Key Bank of England Survey Shows No Let up in Wage Inflation Expectations

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The Bank of England could face a protracted period of wage increases in 2023 according to a key survey of businesses, suggesting core inflation in the UK might prove stickier than expected.

The Bank's latest Decision Maker Panel (DMP) survey of Chief Financial Officers from small, medium and large UK businesses showed businesses’ inflation expectations were broadly unchanged in December.

Over the next year, businesses expected their own output prices to increase by an average 5.7%, unchanged from the previous month, although the three-month average fell from 6.2% to 5.9%.

The Bank looks closely at the DMP for a guide as to how persistent inflation is likely to be, and how much it needs to raise interest rates.

The survey showed CPI inflation expectations stood at 7.4% one-year ahead in December, up from 7.2% in the November survey.

Three-year ahead CPI inflation expectations increased by 0.1 percentage point to 4.0%.

Expectations for wage growth over the next year rose by 0.5 percentage points in December to 6.3%.

The Bank of England has been raising interest rates to try and lower demand in the economy and bring domestically-generated inflationary pressures back under control.

However, signs of ongoing labour market resilience suggest wage pressures might remain elevated, ensuring inflationary pressures remain well ahead of where the Bank is currently expecting.

The Bank hiked rates by a further 50 basis points in December but two members of the Monetary Policy Committee voted for no change, arguing that an economic slowdown would inevitably bring inflation lower again.

This has prompted financial markets to expect the Bank to soon end its hiking cycle as more members subscribe to the view.

However, a halt to the hiking cycle could become more elusive if wage pressures respond slowly to rising interest rates and remain at levels consistent with excessive inflation.

The DMP survey reveals that expected wage growth has gradually risen since the question was added back in May, by a total of 1.5 percentage points.

Realised annual wage growth also increased in December to 6.6%, an increase of 0.5 percentage points on the month.

That said, the survey also found recruitment difficulties were reported to be easing.

Wages and employment are lagging indicators in the cycle, therefore it could be that the ongoing economic slowdown might eventually result in a labour market downturn later in the year.

For now, however, the DMP survey's findings suggest it is too soon for the Bank of England to end its hiking cycle.

"Our view is that the majority of the MPC will want to see more concrete and significant signs that activity is weakening, the labour market is loosening and actual wage growth is slowing before calling a halt on the interest rate hikes," says Paul dales, Chief UK Economist at Capital Economics.

"We don’t think those signs will emerge until after the next two policy meetings in February and March. That’s why we think rates will rise by 50bps at each of those meetings to a peak of 4.50%," adds Dales.