Enjoy rising wages while they last – it won't take much to slow things down

http://www.theguardian.com/business/economics-blog/2015/jun/17/enjoy-rising-wages-slow-things-down

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The equation is simple. A fall in inflation coupled with an increase in wages equals a boost to living standards. Real incomes – pay adjusted for prices – are growing at an annual rate of 2.7%, a level that has not been seen since before the financial crisis broke in 2007.

This is a sweet spot for the economy, with inflation driven down by last year’s plunge in oil prices and wages pushed up by the competition for labour as unemployment falls. In certain sectors, such as construction, and retail and hospitality, earnings rose by 4%.

Jobs growth has slowed a bit in recent months, but the 114,000 increase in employment was still a solid performance. The unemployment rate is almost back to pre-crisis levels.

The big question is whether the sweet spot will last. One potential problem is the weakness of productivity, which has been persistently and abnormally weak for the past seven years. Unless there is an improvement in output per worker, higher earnings growth will eventually feed through into higher inflation.

Related: UK wage growth hits four-year high of 2.7% in April

That would bring forward the date at which the Bank of England starts to push up interest rates. While still some way off, the latest earnings data may encourage the two MPC members – Martin Weale and Ian McCafferty – who were voting to increase the cost of borrowing before last autumn’s oil price slump to suggest that it is time to act.

A second reason for caution is that inflation will start to edge up in the second half of the year unless last year’s big drop in the cost of crude is repeated. That looks improbable, and by the end of 2015 the annual inflation rate could be close to 1%. To sustain the current rate of 2.7% real earnings growth, pay will need to be rising by close to 4%.

For that to happen, the economy needs to keep growing at a reasonably rapid lick. The slightly softer tone to the labour market in the three months to April could well reflect pre-election caution. But the latest survey of consumer confidence from Markit, taken after polling day, points to a relatively downbeat mood.

It would not take much – a spiralling crisis in Greece, a tough summer budget, fears of aggressive tightening of policy from the Bank of England – to slow things down. Enjoy the sweet spot while it lasts.