BoE Actions on Wages Speak Louder Than Words

Ah, sunny Fridays. This time of year, they make me long for the great outdoors, a romp through green hills and wildflowers with bunnies underfoot^[i] and falcons overhead. But every now and then the financial news world offers a tasty treat that makes me ever so glad to be in the office when it is lovely outside as the weekend approaches. Today is one of those days, thanks to the Bank of England (BoE) and its accidental killing of a popular economic theory. There may not be any direct market takeaways, but anything that helps put central bankers’ talk and actions in perspective can help investors.

On its face, the news is humdrum: The BoE announced an average 4.0% pay raise for its 5,000-strong staff, whom other companies were reportedly wooing with higher pay in light of the UK’s so-called cost-of-living crisis. That is more or less in line with the latest inflation rate, which was January’s 4.2% y/y, giving bank staff a retroactive catch-up.^[ii] As a headline, it shouldn’t rate.

But! The BoE has been rather, shall we say, outspoken on the topic of wages. Two years ago, labor leaders, politicians and society at large raked BoE Governor Andrew Bailey over the coals for demanding UK workers demonstrate “quite clear restraint” during the annual wage-bargaining negotiations, lest fast wage growth fuel hot inflation.^[iii] When inflation soared despite BoE rate hikes and a continued fall in real (inflation-adjusted) wages, Bailey stuck to his script, blaming “completely unsustainable” pay raises for inflation’s painfully slow easing process and implicitly threatening to rate-hike the country into recession if workers didn’t stop trying to overcome fast-rising living costs.^[iv] That was just two months after BoE economist Huw Pill made some awkward comments about pay increases and profit margins causing inflation that the entire world took out of context and falsely reported as “people need to accept that they’re worse off.” It was a poorly articulated Phillips Curve argument, not “let them eat cake,”^[v] but the reputational damage was done.

And ever since, the BoE has paid hyper-close attention to wage growth, citing its continued elevation as reason not to cut rates yet despite the nascent fall in GDP. So you might think that it would be very loath to give workers a big raise, especially one that is higher than its forecasted inflation rate over the next year. But it seems officials are refusing to drink their own Kool-Aid, and the financial press is having a field day with the ostensible hypocrisy.

Far be it from me to know exactly how these deliberations went. But it seems to me that if BoE officials were serious and actually believed wages were inflation’s primary cause, they would try to set the standard. After all, their job is to keep inflation around 2.0% annually and no higher than 3.0%, implying they have a duty to do everything in their power to fulfill that mandate. If they truly believe wage hikes put that goal at risk, it seems fair to say Bailey should have told the staff to suck it up and deal with stagnant pay. If we accept that actions speak louder than words, then the BoE’s actions tell us they secretly believe the Phillips Curve is baloney. 

Which would be one of the more sensible revelations ever! Because the BoE’s pay history shows how all of this really works: Inflation drives wages, not the other way around. In 2020, the UK’s full-year inflation rate was 1.0% when using the Office for National Statistics’ preferred measure, which includes owner-occupiers’ housing costs.^[vi] Accordingly, BoE staff got a 1.25% bump in early 2021. That year, inflation accelerated to 2.5%, and BoE staff pay rose a smidge faster in response, by 1.5% in early 2022.^[vii] Then inflation skyrocketed, hitting 7.9% for 2022.^[viii] The ensuing staff raise? 3.5% in March 2023. Which brings us to 2023’s full-year 6.8% inflation rate and the current 4.0% pay rise.^[ix]

To add it all up: Staff pay lagged the inflation rate and still hasn’t caught up, which probably explains why workers keep telling the BoE’s internal survey they believe they are underpaid.^[x] The BoE forecasts a continued inflation slowdown this year, leaving the annual rate near its 2.0% target. So maybe this year workers will regain a little more purchasing power than they have lately. That would also be consistent with pay growth easing after inflation slows and taking longer to get back to normal, which is also the norm and is happening in the UK now. (Similarly, wages lagged inflation in much of the developed world, including the private sector.) Lingering wage growth is a beneficial after-effect of the past few years’ fast-rising prices, not a driver of more inflation to come.

Now, central bankers have a long, long history of not quite matching actions with words. That includes the BoE, whose former head once got the nickname of Britain’s unreliable boyfriend because he flip-flopped on interest rate guidance so much. Therefore, I don’t seriously expect BoE officials to suddenly change their Phillips Curve tune and announce that it is suddenly looking only at money supply and loan growth as it mulls monetary policy. They will probably keep singing from the same hymn sheet, keeping wage growth front and center. Yet they have already shown, if not told, you that you can tune this down. Their pay, like all pay, changes at a lag.