Bank of England

Tuesday, May 30, 2017 - 09:02

UK Reality Check: BOE Wage Growth Forecasts Implausible: CEP


--Hard Brexit, cut in EU migration to compromise nominal wage growth further
--Ex BOE MPC Blanchflower: Bank Again Set To Miss Earnings Forecast

LONDON (MNI) - Bank of England Monetary Policy Committee claims that nominal wage growth will return close to 4% by 2019 are "rather implausible and over-optimistic", according to two respected academics at the Centre for Economic Performance.

Interviewed for the latest MNI Reality Check, Professor Stephen Machin, Director of the CEP, along with Rui Costa, a fellow researcher at the body, said that existing pressures would not alleviate enough over the near-term horizon to justify the MPC's prediction laid out in the Bank's latest Inflation Report, published earlier this month.

"The current situation in the advent of the EU Referendum has brought pressure over the sterling exchange rate as well as uncertainty for businesses in general. The combination of these factors has caused inflation to rise. It may even dampen nominal wage growth as employers' uncertainty over their access to the European market is not resolved," Machin said.

"We do not expect either of these factors to improve significantly within the time frame of 2019, hence making the 4% wage growth forecast unlikely," he added.

Bank of England Governor Mark Carney recently warned that 2017 would be "challenging" for workers, prompting a 1.0pp downward revision of the MPC's forecast for average weekly earnings during this year to 2.0% 3m y/y. Growth, however, was then expected recover in the following two years, picking up to 3.5% in 2018 and 3.75% in 2019.

As such, Machin stated, "according to our latest CEP Real Wage Update, co-authored with Professor David Blanchflower, the prediction of 4% nominal wage growth by 2019 seems rather implausible and over-optimistic".

In an exclusive interview with Market News, Blanchflower, an ex-BOE MPC member and now economics professor at Dartmouth University, said the central bank needed to "wake up".

No fan of the central bank's reading of the UK labour market for over 10 years Blanchflower again castigated them for the continued over-optimism on earnings.

"I've written to them endlessly, I've written columns endlessly, telling them that they have no clue what they are doing. The economics of la-la-land, I would call it," Blanchflower said.

"In the last ten years, they have shown absolutely no understanding of the UK labour market at all," he added.

According to Blanchflower, near-4% wage growth is simply too optimistic and he, along with others in the field he has collaborated with on this, feel a figure around 2% is more reasonable.

"Look at what their agents say, look at what settlements say. XpertHR brought out another report showing you that every month in the last three years, wage settlements have been 2.0%...and our view is that nominal wage growth is 2.0% with a little bit of noise and so it has turned out," he said

"So, why do they keep saying it is going to be 4.0%? Presumably because if they say its 2.0% then they are going to have to do something. So, I just think it is a complete embarrassment," he added.

Though he accepts a rise to 4% could happen if this was partly attributed to a boost to UK productivity, Blanchflower insisted that "they [the BOE] have no explanation as to why productivity would suddenly pick up."

Blanchflower eluded specifically to a "killer chart" in the CEP's May edition of the Real Wage Update which he co-wrote alongside Machin and Costa, a table that highlights the Bank's continued difficulty in tracking nominal wage growth.

The table shows the Bank's track record of initially over-estimating wage growth in 2016 and 2017 (typically around 3.5%-4%) at the start of the forecast horizon only to then revise this down to around the 2% mark as they approached the end of it.

The paper read, "A key question - to us at least - is why does the MPC not seem to learn from its past errors and why are no members of the MPC challenging the base?"

"We've been saying all along, 'just take 2.0%, with a little bit of noise' and now we're in a position where real wage growth has become negative ... The whole basic thing that they've said is that 'obviously inflation is going to come down, nominal wage growth is going to be 4.0% so then real wage growth is going to be positive'. Sorry sunshine, it's going to be negative," Blanchflower said.

"That means the whole of their forecast is completely wrong and we're going to have to see at some point down the road, with all the risks on the downside, that once again they're going to look completely hopeless," he added.

A recent MNI analysis piece ('Analysis: UK Real Wage Growth Set To Turn Negative') correctly foresaw regular real wage growth turning negative in March for the first time in just under three years. This also came as regular nominal wage growth dipped to 2.1% 3m y/y, the lowest since December 2015.

The main worry associated with the erosion of household's real incomes is that this will translate into lower spending on the high street, to drag on real GDP growth. We have already seen evidence of this with Q1 retail sales, which fell 1.4% q/q, the lowest quarterly outturn since Q1 2010.

That said, nominal sales values remain high which suggests that for the moment consumers are willing to dig deeper into their wallets to sustain their current standard of living.

To do this, however, they are dipping into their savings, as evidenced by the household spending to savings ratio slipping further. Once this savings buffer is used up households will then likely trim back on non-essential expenditure.

As part of the CEP's analysis in the run up to the upcoming UK general election, Machin and Costa co-authored a report analyzing the evolution of UK real wages and living standards since the financial crisis and outlined a number of key findings (https://goo.gl/D8vu7G).

One of these observed that the recent pattern of real wage growth in the UK was "weaker" than that in the majority of other OECD countries.

This is in contrast to the UK unemployment rate which, compared to many of its foreign neighbours, "offers a more positive conclusion than its real wage counterpart," according to CEP's Costa.

Since the financial crisis, the UK's adjustment process has come in the form of changes to workers' wages and hours worked as opposed to at the employment margin.

"It can even be argued to be a more successful way of adjustment given the costs of unemployment on long-run outcomes of workers," he added.

However, the pair point out that it is the "persistent" shift in the composition of employment towards self-employment and part-time work that is "worrying".

"The significant and non-temporary increase of these low wage/income jobs in economy, can be argued as "job quality" loss. This means there is also more labour market slack than the measured unemployment rate suggests," said Machin.

Evidence of this, according to Costa, is that many workers are underemployed in "insecure work", looking to work for longer hours.

It is young workers (18-21), who are "particularly vulnerable" in the UK labour market, seeing their real wages fall a sizeable 16% since the financial crisis according to the CEP report, faring the worst during this time compared to any other cohort.

Machin said that this was supported by research evidence that has shown there are often "sizeable 'scarring' effects for cohorts that enter the labour market in economic downturns".

"More recently, full access to the safety net of welfare state is often poor among this group, given the high incidence of alternative working arrangements such as self-employment, zero-hour contracts and part-time employment.", he added.

Switching focus to the UK's decision to leave the European Union, the pair believed a hard Brexit, effectively ceasing the free movement of workers to and from the UK, would, on a net basis, only be detrimental to the wages of UK workers.

"Perhaps the most direct implication of restricting labour flows will be in terms of productivity," said Costa.

"Firms will face constraints in the pool of candidates they can potentially employ, leading to a likely drop in productivity given that poorer matches will be made," he added.

This would lead to "obvious implications" for UK competitiveness with "potential losses" not a farfetched possibility.

"Despite the common belief that a drop in the labour supply caused by restrictions in labour flows would increase wages as a result, the likelihood of this ceteris paribus analysis is rather low and easily outweighed by strong downward pressure of the demand for labour as consequence of loss of competitiveness due to falls in productivity and increasing unit of labour costs," said Machin.

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com
--MNI London Bureau; +44 203-586-2226; email: jamie.satchithanantham@marketnews.com

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