Sunday, January 22, 2023
Inflation is far from licked and pay is starting to become a worry
Posted by David Smith at 09:00 AM

My regular column is available to subscribers on This is an excerpt. Not to be reproduced without permission.

Recent days have brought what looks on the face of it to be more good news on the economy. Inflation fell again to 10.5 per cent and appears to be past its peak, which is welcome. We should never forget that, in the absence of government price support, in particular this winter’s freeze on household energy bills at an average of £2,500, we could have been looking at 13 or 14 per cent consumer price inflation by now.

The labour market is softening, but only slightly, with a small rise in unemployment in the latest three months not enough to lift the unemployment rate above a very low 3.7 per cent. There was also tentative evidence in the latest three months that more people in older age groups, 50-plus, are returning to the labour market; becoming “economically active”.

It is early days, but there is no reason as yet to change the story I gave you here on New Year’s Day, which was that this will be a year of mild recession, at worst, and falling inflation. You should not need Jeremy Hunt’s video explaining inflation with the aid of coffee cups to be able to predict a fall in inflation this year.

I hate to be the bearer of bad news, however, but these things are often in the eye of the beholder. What to many would look like a predictable and reassuring set of figures has the capacity to set alarm bells rising amongst others.

Take the inflation figure for a start. Yes, the headline rate fell again but, looked at from the perspective many consumers, or the Bank of England, the picture was much less reassuring.

Food price inflation, as has been widely noted, rose to 16.8 per cent last month, its highest yet in this sequence. A year earlier, in December 2021, it was a mere 1.6 per cent. Combine that with the fact that, in spite of the energy price freeze, household fuel bills were up by 88.7 per cent over the latest 12 months and you can see why people might have decided it was too soon to celebrate.

Indeed, figures on Friday, the widely followed GfK index of consumer confidence, showed a three point fall this month, taking it down to almost its all-time low, reached last September. Most measures in the index fell. People are gloomier about the economy over the next 12 months than most economists and think this is bad time for major purchases. The 1 per cent fall in retail sales last month, for a drop of nearly 6 per cent over the past 12 months, can be seen in that context.

The weakness of consumer confidence in the GFK index is something to behold. It has been running since 1974 and has thus existed through many recessions and crises. For confidence to be weaker now than ever before, including the global financial crisis and the pandemic, is quite something. People expected something better than this post-pandemic squeeze and sharply higher bills.

Those doubts about whether this is a time for major purchases also probably played a role in another strikingly weak survey, this time on the housing market from the Royal Institution of Chartered Surveyors. It tells a story of potential buyers being scared off by higher mortgage rates and of deep gloom on price and expected sales. The balance of surveyors reporting falling prices was the highest since 2010.
Looked at from another angle, that of the Bank from its headquarters in Threadneedle Street, there were also things to worry about in the latest figures.

Yes, inflation is down from the excruciatingly embarrassing to the highly embarrassing but has further to fall before it is merely very embarrassing but there was bad news in the detail.

“Core” inflation, which excludes energy, food, alcohol and tobacco, remained stuck at 6.3 per cent last month, the same as in November. It started the second half of last year at 6.2 per cent, briefly rose to 6.5 per cent but looks so far stuck at a level incompatible with the official 2 per cent inflation target. Economists describe this as inflation persistence and fear that it may be more persistent in the UK than elsewhere. Even when energy and food prices settle down, core inflation has to fall before the job can be said to be done.

Even more worrying for the Bank were the latest pay figures. Though much of the commentary focused on the fact that real wages are falling, which they are, a 7.2 per cent annual increase in private sector average earnings in the latest three months is something to give the Bank the shudders. The Treasury will be similarly concerned that public sector pay is rising at an unsustainably low 3.3 per cent rate, and is due a catch-up, however much ministers try to fight it.

That 7.2 per cent private sector earnings growth is being led, not by sectors like hospitality, where labour shortages are biting but pay is rising by 5.9 per cent, or construction, 6.3 per cent, and certainly not recession-hit manufacturing, 5.4 per cent, but by the generally higher paid finance and business services sector, where regular pay is rising by 7.6 per cent. I said regular pay for a reason. For once, earnings in finance and business are not being driven by bonuses.

Why should the Bank be worried about this? Because, for once, inflation is being driven by the service sector, what we usually think of as domestically generated inflation. Service sector prices rose by 0.7 per cent last month, against 0.1 per cent for goods prices, and are up 6.8 per cent over the past 12 months, their highest rate yet in this cycle.

There are also indications starting to come through from pay settlements that the Bank will find troubling. XpertHR, a firm which monitors them, says that after a long period in which pay settlements were stuck at 4 per cent, in spite of high inflation, they rose to 5 per cent in the final three months of last year, and very early indications are pointing to an average of 6 per cent so far this year.

Employees will see this as perfectly justified in the light of high inflation, with pay awards still a long way below rising prices. The Bank will regard it as a warning sign that higher inflation is becoming embedded. A half-point rise in Bank Rate early next month now looks certain. The Bank will need more reassurance on inflation and pay to be sure that by then it has done enough.

On the surface, everything looks better for the economy than we might have feared. Beneath it, there are some worrying undercurrents.