Pay rises and inflation - can the CB head off a wage-price spiral?

 

Can high interest rates ‘hurt to work’ without causing recession?

David Smith

Wednesday June 22 2022, 12.01am, The Times

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Astrike is crippling the country’s transport system and ministers seem powerless to do anything about it, apart from plead from the sidelines. It is almost as if decades of union reform and rail privatisation never happened. All it needs now to complete the 1970s scenario is for Boris Johnson to call a “Who governs Britain?” election — though that did not work out too well for Sir Edward Heath in 1974.

Meanwhile, the government’s story on pay has undergone a 180-degree shift. A year ago, when furlough-distorted figures suggested, misleadingly, that pay was racing ahead, the prime minister celebrated it as evidence of a high-wage economy. Now the government is pleading for pay restraint, echoing Andrew Bailey, the beleaguered Bank of England governor. Both are worried that big pay settlements now will mean prolonged high inflation later, though on the face of it, there is not too much to worry about.

The latest figures from the specialist consultancy XpertHR, just published, showed that median basic pay settlements in the three months to May were 4 per cent, well below an inflation rate now running at 9 per cent and set to hit 11 per cent later in the year, according to the Bank.

Pay awards are accelerating — a year ago the median increase was 2 per cent, at the beginning of the year 3.2 per cent — but remain modest.

That leaves two worries for the authorities. The first is what comes next? Settlements so far may not reflect the full horrors of an inflation rate that is so far above the official 2 per cent target it might as well be in a different solar system.

The second is the disconnect between regular pay, rising by 4.2 per cent in the latest figures, and total pay, including bonuses, up 6.8 per cent. Bonuses these days may reflect not just awards to “fat cat” bankers but also what employers are shelling out to recruit and retrain staff in a tight labour market. The good news is that the bonus effect may be fading after an April peak.

The other bit of good news, though that depends on where you stand, is that the exceptionally tight labour market — a product of a shrinking workforce — may already be starting to loosen under the impact of a sharply slowing economy.

The Treasury has another worry. Last October, when he unveiled his comprehensive spending review, Rishi Sunak announced that he was lifting the one-year pay freeze unveiled a year earlier and would now allow “fair and affordable” public sector pay increases.

The chancellor had in mind an increase of about 2 per cent, the kind of figure the pay review bodies for public sector workers have been working with. At the time, Sunak had an official forecast from the Office for Budget Responsibility that had inflation peaking at 5 per cent this spring before falling rapidly to 3 per cent or so. This was an underestimate, even without the additional upward pressure from the Russian invasion of Ukraine.

The fear now is that bigger public sector pay settlements could be another nail in the coffin of Sunak’s deficit reduction plans. He has been forced to unveil expensive support packages in response to the cost-of-living crisis; soften his national insurance hike; and is under pressure to abandon some of his planned tax increases, including next year’s raise in corporation tax from 19 per cent to 25 per cent. A big increase in public sector pay, which make up between a fifth and a quarter of government spending, would be a further blow.

As for the Bank, one concern was put well by Sir Charlie Bean, its former deputy governor, in a Mouradian Foundation webinar I chaired a few days ago. This was that, even if settlements are not high at present, private sector workers will seek in next year’s pay round to make up for the drop in real wages suffered this year.

Private sector workers are not heavily unionised, as I wrote recently. Just one in eight belongs to a one. But they are still capable of pushing for higher pay and bigger increases next year, implying that high inflation could become “embedded” and thus harder to get rid of.

This was the context of a speech by a member of the Bank’s monetary policy committee (MPC) earlier this week, one of the more hawkish I can remember. Catherine Mann, who voted for a half-point rise in interest rates last week (the majority decision was for a quarter-point), hinted strongly she will do the same at the next meeting on August 4.

She is worried about “robust wage growth”, “widespread bonuses” and that element of inflation caused not by international energy and food prices but domestically generated. She is also concerned that, if the Bank raises rates at a much slower rate than America’s Federal Reserve, an already weak pound will fall further, adding to inflation.

More aggressive policy “reduces the risk that domestic inflation already embedded is further boosted by inflation imported via a sterling depreciation”, she said, while also opening the way to bring down rates in the medium term once the danger has passed.

Bank of England rate-setter Catherine Mann raised fears about wage growth

GETTY IMAGES

The warning from other MPC members is that they too will respond with higher rates if pay growth accelerates. Will it work? Wage bargainers do not stop mid-negotiation and decide that they had better moderate their demands because the Bank is putting up interest rates. The process is more brutal than that. Higher rates work instead by slowing the economy (not difficult at present), risking recession and pushing up unemployment.

Sir John Major, who was chancellor for a year before he became prime minister, coined the phrase “if it isn’t hurting, it isn’t working”. The high interest rates of the late 1980s did work, tipping the economy into the 1990-92 recession.

We must hope the worries about pay are overdone, and that that will not be necessary this time.

David Smith is Economics Editor of The Sunday Times

Minimum alcohol pricing experiment fails...

 

SNP’s alcohol unit price policy ‘just drove drinkers to spend less on food’

Health initiative dubbed a ‘failed experiment’ after researchers find ‘no clear evidence’ it dissuaded alcoholics

ByMax Stephens7 June 2022 • 12:00am

Nicola Sturgeon believed the introduction of minimum unit pricing in Scotland would ‘save lives’ CREDIT: Ken Jack/Getty Images Europe

A flagship SNP health policy failed to curb problem drinking but forced alcoholics to go without food, a major study has found.

Scotland became the first country in the world to introduce minimum unit pricing (MUP) for alcohol in May 2018, currently fixed at 50p per unit.

But in a landmark report on the effectiveness of the policy, researchers from Sheffield and Newcastle universities found “no clear evidence” it dissuaded alcoholics from drinking.

In some cases, heavy drinkers spent up to 29 per cent less on food, utility bills and other items, according to data collected from 100,000 participants.

The average total spending on alcohol among this group increased by nearly 30 per cent, rising from £83 to £107 per week. 

Findings from 170 interviews revealed the policy drove alcoholics to borrow money from family and friends, pawn their possessions, run down their savings, and forced them to rely on food banks or other forms of charity.   

Nicola Sturgeon had lauded the policy in 2016 as “a vital public health measure with strong support from those who work in the frontline of alcohol misuse”.

“It will save lives,” she wrote on Twitter the day after the Scottish courts agreed to back the controversial policy following four years of legal challenges from the Scotch Whisky Association.

‘Increased financial strain’

The report, published by Public Health Scotland, revealed those with alcohol dependence “received little support or information before the policy was rolled out”.

In the report’s conclusions it says: “There is no clear evidence that this (MUP) led to reduced alcohol consumption or changes in the severity of alcohol dependence among people drinking at harmful levels.

“There is some evidence it increased financial strain among some economically vulnerable groups.”

The report adds there was no “clear evidence” the policy led to an increase in criminality and drug use. 

The Institute of Economic Affairs, a free market think tank, said the findings would be the “final nail in the coffin of minimum unit pricing”.

Christopher Snowdon, head of lifestyle economics at the organisation, said: “The Scottish Government will try to put a brave face on it, but there is now little doubt that minimum pricing has been a failed experiment that has cost Scottish consumers £270 million.”

People with alcohol dependency responded differently

Prof John Holmes from the University of Sheffield, who led the overall study, said that although MUP was effective in reducing overall sales, those with alcohol dependence responded “in very different ways”.

He said: “Some reduced their spending on other things but others switched to lower strength drinks or simply bought less alcohol.

“It is important that alcohol treatment services and other organisations find ways to support those who do have financial problems, particularly as inflation rises.”

Helen Chung Patterson, public health intelligence adviser at Public Health Scotland, said the research “further develops our understanding of and insights into this important population and how they have responded” to minimum unit pricing (MUP).

“People who drink at harmful levels, and particularly those with alcohol dependence, are a diverse group with complex needs who often experience multiple interacting health and social problems,” she said.

A Scottish Government spokesman said they would “carefully consider the findings”.

They said in the 12 months following the introduction of MUP there was a two per cent decrease in off-trade alcohol sales and a 10 per cent decrease in alcohol specific deaths in 2019.

Latest statistics for 2020 showed alcohol specific deaths had increased by 17 per cent in Scotland, they added.

Why so many unfilled vacancies?

 A vital read on supply-side policy and unemployment - you must have a real understanding of this in order to write coherently about it; a challenge, I know, but you are studying a very difficult subject:

Benefits Britain is back – and it's condemning millions to dependency

Don't blame Brexit for worker shortages. The UK has a hidden crisis of mass joblessness

FRASER NELSON2 June 2022 • 9:30pm

My wife took the kids on holiday for half-term and I have never felt more grateful to be left at home. EasyJet cancelled their flight with a day’s notice. She found another, on Wizz Air, and they’d all boarded before the pilot told them it had been cancelled, due to lack of cabin crew. The same story can be heard nationwide: mayhem due to a lack of baggage handlers, check-in staff, cleaners. It’s 1970s-style bedlam, but there are no strikes. The aviation industry has vacancies galore. Salaries are surging – but they still can’t hire.

They’re not alone. Anyone who can find a flight to Britain would discover hotels closed for lack of cleaners, restricted restaurant menus due to lack of chefs, and “help wanted” signs on every high street. Every country that locked down has had problems readjusting, especially losing people to early retirement. But studies show that, for some reason, Britain has done worse than almost anywhere else in getting people back to work.

It’s traditional, at this point, to blame Brexit – and say it’s time for more immigration. The boss of Collinson, which runs airport lounges, did so yesterday: unemployment is at the lowest in 40 years, he said. So with no Brits available, what option is there but to look abroad? For almost two decades, employers have done just that: solve staffing issues by importing low-cost workers from overseas. That reflex is very much still there, twitching away. But dig deeper, and this argument collapses.

Immigration has bounced back. There is no Brexit-sized hole in our workforce; not anymore. Immigrants now account for one in five workers in Britain, the highest ratio ever. Brexit certainly has made immigration less controversial: polls show far greater democratic consent under the new points-based system. But as things stand, Brexit hasn’t made any measurable difference to the numbers. So we can’t blame absent Poles or Italians for the shortages: migrants are playing a bigger part than ever in keeping Britain moving.

The problem lies with the Brits. The low unemployment claim is a mirage. Britain has, in fact, been suffering a period of mass joblessness as big as any in our recent history. The proportion of people who are neither in work or looking for it is higher now than it was in the mid-1970s. More than five million people were claiming out-of-work benefits at the last count – a figure as big as the population of Scotland. But many of them don’t count as unemployed, because they’re not looking for jobs. So – presto! – they vanish from the national debate.

This overall figure masks horrific local blackspots. In Blackpool, official figures show 26 per cent on out-of-work benefits. In Middlesbrough it was 23 per cent, in Hartlepool 22 per cent, in Manchester, it’s 18 per cent. All of these places have thousands of jobs going, which makes the joblessness all the less defensible. These official out-of-work figures will, of course, include the long-term sick and they are always six months out-of-date. Things will have improved by now, a bit. But the general problem (and scandal) remains.

Why? How did we get here? How did Universal Credit, the flagship reform of the Cameron era, start to produce the problems that it was designed to solve? It was created with strings of conditionality on welfare payments, with sanctions imposed if people turned down jobs or missed face-to-face meetings. During lockdown, the conditions were abandoned – and never properly restored. So the new system has started to trap people in welfare as surely as the old one did. It has started to become an issue in Cabinet.

Thérèse Coffey, the Work & Pensions Secretary, is pushing for reform. For example, it’s currently possible to get out of regular appointments with a work adviser if you do just nine hours of work a week. Coffey wants to make this 12 hours – and in this, she deserves support from the rest of the Cabinet. If anything, they should be going further. In a country crying out for workers, this could easily be raised to 24 hours. This is the time for ambition – and for the return of a tough-love policy that Iain Duncan Smith delivered to such striking effect.

His reforms meant that, during the Cameron years, the incomes of those at the bottom increased far faster than those at the top. Work paid. More jobs were created than economists thought possible. It was a progressive triumph – and an experiment that’s ripe to be repeated. The logic is just as compelling now. Moving from welfare to even minimum-wage work makes someone about £6,000 a year better off: the best remedy to the cost-of-living crisis. Not to mention the great worker shortage crisis.

And given the rising cost of government – via ever-increasing taxes – we can take a step back and ask a broader question. The welfare state is obviously a safety net – but how big should it be? Britain now has one of the highest minimum wages in Europe and more job vacancies than at any time since records began. But still, a third of all households are claiming means-tested benefits. Was this intentional? Or have we just slid into this situation, because no one quite worked out what is going on?

Nothing is more likely to help people move from welfare into work than actual face-to-face consultation, as studies show. So asking healthy people to see a work consultant if they’re doing less than 24 hours a week is hardly onerous. Or, with so much help needed, unreasonable. The last decade dealt with the “idle Brit” myth: people were not inherently lazy or work-shy. When a bad system was replaced with a good one, things got better. They could get better again.

Universal Credit was created by a principle: that welfare dependency is cruel. It is not compassionate to write cheques and abandon people in edge-of-town housing estates while growing the economy with imported labour. The main aim is to save lives, not money – and, this time, rebuild the economy after the devastation of lockdowns. The jobs are there. The workers are there. We just need a government with the courage and resolve to put the two together. If Boris Johnson is still interested in a post-Covid reform agenda, he really should look no further.

SPICED vs WePIDEC - what's up with the £?

 

Some very useful exchange rate info here - it is much more than a question of moving interest rates around:

Bank of America is wrong about the weak pound

The story so far is essentially one of dollar strength, rather than sterling weakness

JEREMY WARNER5 June 2022 • 6:00am

Jamie Dimon, boss of JP Morgan Chase, thinks an economic hurricane is coming. Announcing a one in ten headcount reduction at Tesla, Elon Musk says he has a “super bad feeling” about the economy. John Waldron, chief operating officer of Goldman Sachs, warns that markets have yet to come to terms with the current, unprecedented confluence of economic shocks.

Amid it all, the UK is said to be in a particularly difficult position. So claims Kamal Sharma, foreign exchange strategist at Bank of America. International investors are increasingly of the view that the pound sterling has taken on emerging market characteristics, he warns.

I’m not sure about Dimon’s hurricane or Musk’s “super bad feeling”. Perhaps they are right, though it is worth noting that both these pundits are quite late to the party. Predictions of catastrophe have been the presiding narrative for some months now, and it hasn’t happened yet.

But I do take issue with the idea that the pound is about to undergo some kind of fundamental repositioning that destroys its remaining reserve currency status.

This is not to argue it’s impossible. There have been many such moments of currency reappraisal in Britain’s long retreat from empire. 

In 1931, just before Britain abandoned the gold standard, a pound would have bought you 4.87 US dollars. Immediately afterwards, your pound was worth a considerably reduced but still respectable $3.69. Unfortunately, that was just the beginning. The next big devaluation was in 1949; this was a whopper which reduced the value of the pound by around 30 percent and essentially marked the end of sterling’s reign as the world’s pre-eminent currency for international trade

Against this, Harold Wilson’s famous “pound in your pocket” devaluation was a comparatively minor event - “just” 14 percent to $2.40. After that came the collapse of the Bretton Woods fixed exchange rate regime in the early 1970s, when there was another stomach churning downward lurch. All of these post war devaluations reflected an increasingly harsh reality — that the British economy was progressively losing international competitiveness, resulting in repeated balance of trade crises.

Just to bring things up to date, there have since been three standout such moments - the ERM debacle in 1992, the financial crisis in 2008/9, and the vote for Brexit in 2016. 

The position has been relatively calm since the last of these episodes, with the pound bouncing around within a quite narrow range of about 10 percent against both the dollar and the euro. Until the beginning of this year, that is. 

Since then, the pound has been the world’s third worst performing major currency, after the Swedish krona and the Japanese yen. There is obvious potential for things to turn uglier still. All the same, the story so far is essentially one of dollar strength, rather than sterling weakness. Against the euro, the pound has lost only a couple of cents, and the trade weighted index is actually marginally up on the year.

This is not to lightly dismiss Bank of America’s analysis, which raises important concerns about sterling’s continued credibility as a reserve currency. Obvious failings in the Bank of England’s inflation targeting regime have left policymakers in the invidious position of having to raise interest rates into a fast slowing economy — never a great look and often symptomatic of a downward spiral in the currency.

As Bank of America’s Sharma points out, this makes the Bank’s position notably different from that of the Federal Reserve in the US, which is raising interest rates against the backdrop of a still strong economy. Rightly or wrongly, there have also been questions over the Bank of England’s independence. Too often it seems a creature of the Government’s need for deficit financing.

But the Bank’s credibility is just the half of it. Since Britain left Europe’s single market, there has been a notable deterioration in the country’s external trade position, bringing back memories of previous balance of payments crises. 

Even a widening trade deficit doesn’t really matter provided there is sufficient in the way of capital inflows to finance it. But if these start to wane, then the currency is going to be in some difficulty.

Throughout much of last year, when there was a general perception that UK assets were undervalued by comparison with peers, this wasn’t much of a problem. The money flowed in as required, and the exchange rate actually appreciated somewhat.

But this undervaluation may now have gone, and with rising interest rates more of less everywhere, UK assets may have lost some of their comparative appeal. 

Global liquidity conditions are deteriorating, and with interest rate normalisation, net cross border flows have slowed. With such a large current account deficit, Britain is particularly reliant on “the kindness of strangers”, and therefore vulnerable to any loss in international confidence.

All this is no doubt true. Brexit has made trade with Europe, still the UK’s largest external market, more difficult and costly, while the UK Government has so far failed to demonstrate meaningful economic gains to compensate. 

The Government’s refusal, moreover, to acknowledge that Brexit has played any part in deteriorating trade only further inflames the situation, making it look as if ministers have their heads buried in the sand.

But here’s where it is reasonable to take issue with the Bank of America analysis. All things are relative in currency markets, and looking around the world today, you would struggle to find a jurisdiction where things look notably better.

Run by an indecisive geriatric, paralysed by an increasingly dysfunctional political system, and torn apart by the poison of its culture wars, the US seems of ever less appeal beyond its traditional reserve currency attributes. 

The EU? Slow moving and severely compromised by its 27 moving parts, it is more exposed than any to the debilitating effect on energy prices of the Ukrainian war. Besides, with rising interest rates, the eurozone debt crisis will be back before we know it. Spreads are already widening worryingly.

As for China, what on earth is the regime playing at? The anti-Western rhetoric alone would be enough to deter all but the bravest of investors. Add in the zero-Covid debacle, the crackdown on tech, on the education sector, on Hong Kong and on the Uighurs and you’d reasonably conclude that China’s economic miracle is over.

In any case, set against the alternatives, the UK doesn’t seem such a bad place for your money. Witness the great outpouring of affection for the monarchy, its institutions still seem relatively robust, and although the fiscal position looks precarious, it is by no means beyond redemption.

There is admittedly no discernable strategy behind the current chaos of intellectually bankrupt policy making, but that seems to be the case more or less everywhere. Can it really be that difficult for a Tory Government to provide the pragmatically driven and predictable policy framework that is required for enterprise to thrive? Sort that out, and so would sterling.