6 June 2023: Wage negotiations turning core inflation into a persistent issue

6 June 2023: Wage negotiations turning core inflation into a persistent issue


  • High wages push service prices up
  • Employment data is almost impossible to believe
  • Business activity continued to slow in May
GBP – Market Commentary

Core inflation is likely to remain high throughout this year’s wage round

Services and composite output data for May were released, and both remained around the same level that was seen in April.

The Services PMI showed that the sector is still well into an expansive phase at 55.2 which pushed the composite number for services and manufacturing combined to 54, from 53.9 previously.

As part of the data, services firms noted strong input costs from wages which have been growing for the past three months. This will continue to add pressure to core inflation and will likely lead the Bank of England to continue to hike interest rates.

The nature of wage increases is that once workers, or their representatives, claim a wage increase, based upon headline inflation at the time that negotiations begin, there is a lag before that increase is paid.

In the meantime, as is the case currently, headline inflation has begun to fall making the pay award appear to be more generous.

To “make up” for their increased costs, firms are forced to increase prices which add to inflation. This is what is labelled the wage/price spiral and can last for a considerable time and slow the fall in the rate of inflation.

In the current data, input costs rose to their highest level since February, as salary costs more than made up for the fall in energy prices.

The Bank of England is closely watching wage settlements in both the public and private sectors. More people have returned to work since the beginning of the current quarter which has helped businesses fill vacancies, although the data for job creation, which shows how businesses are expanding and investing in the business, still is below the level of last year.

Business confidence is also improving with 50% of those firms surveyed expecting conditions to improve, versus 10% who foresee a decline.

The Bank of England’s Monetary Policy Committee still has two weeks until it meets again. There is nothing in the data released since the last meeting that suggested that the committee will do anything other than agree to another twenty-five-basis point increase.

The prospect of still higher interest rates is supplying a cushion for the pound, as speculation continues about when G7 Central Banks will stop their cycles of interest rate hikes.

Yesterday Sterling saw an initial fall which was quickly reversed as the data was released. It eventually closed at 1.2441, just eight points lower on the day.

USD – Market Commentary

Skip-a-hike strategy is gaining more support

The pause in interest rate rises which has now attracted the epithet “skip-a-hike” due to FOMC members not feeling comfortable announcing a definite end to rate hikes, is gaining traction as more regional Fed Presidents “get on board” with the idea of allowing the economy and financial markets to “catch up” with Central Bank’s actions.

A top economist yesterday ruled out a “soft landing” for the economy. David Rosenberg believes that the economy is “barrelling” towards a recession later in the year.

He bases his assumptions on two key pieces of data.

The first is the “weekly lending index”. This shows the level of borrowing by businesses and is currently at its lowest level since 2019 as businesses protect themselves by delaying further investment. The second piece of data is the spread between short-term government debt, which has “blown out” to its highest level since the “dot.com” bubble and the housing crisis that was driven by the sub-prime mortgage fiasco.

Former Merrill Lynch Chief Economist David Rosenberg believes that inflation has already been defeated and the continued rate hikes that have been added since will lead the economy into a recession.

Having hiked rates from close to zero to 5% over the past year without any pause to gauge their effect and allow the “lag” to take effect has meant that the economy is already close to a recession as evidenced by the lack of any real growth in GDP since the beginning of the year.

Jerome Powell appears to be intent on skipping a hike at next week’s FOMC meeting, which appears to “fly in the face” of the Fed’s data dependency, given the number of new jobs created in May. The fact that the unemployment rate rose marginally may have given Powell slightly more confidence that employment is cooling, but that will be a brave call.

FOMC members James Bullard and Patrick Harker both support Powell’s plans, backing the idea of a “June skip”.

There is more data to be released before the FOMC meets, but the idea of a pause, with the warning that it may not be the end of the rate-hike cycle is gaining traction.

The dollar index is still gaining support from the end of the debt-ceiling crisis but could be running out of steam. Having risen to a high of 104.40 yesterday, it fell back to close at 104.00.

EUR – Market Commentary

Rate cycle predicted to end in July at 3.75%

Christine Lagarde is determined to get her message across about the outlook for inflation and the ECB’s determination to use ever-tighter monetary policy to bring it back closer to the Bank’s target.

She made yet another speech yesterday in which she left her audience in no doubt that the Governing Council would vote to hike rates again at its meeting next week.

It is to be hoped that the amount of advance guidance Lagarde is providing to the market is repeated when the time comes to bring the cycle of rate hikes to a close.

U.S. Investment Bank Morgan Stanley, in a note to investors yesterday predicted that the ECB would end the cycle in July when rates reach 3.75%. Given the positivity of her recent speeches, it would be seen as a serious volte-face if the Bank’s President began preparing the market for a pause as early as next week.

Having fallen into recession, Germany is fast becoming the Eurozone’s “problem child” as business confidence ebbs away and export orders begin to dry up.

Although the German Economy Ministry has not put a time on how long the country will remain in recession, it had been generally believed by the market than given the Bundesbank’s relatively sanguine attitude to the contraction of the economy that the downturn would be short-lived.

That is particularly true given the fact that not only is the German Central Bank still in favour of rate increases, but it also believes that the size of increment should be larger.

This puts into perspective the fear that Germany has of inflation and the damage it can do to an economy if it is left unchecked.

Of course, the longer the country stays in recession, the longer it will take for it to recover, a fact that is no doubt not lost on the Chancellor or the Bundesbank President.

The euro is receiving help from Lagarde’s continued hawkish stance. Particularly as she appears able to carry the rest of the Governing Council with her.

Yesterday, the common currency rose to a high of 1.0722 and closed at 1.0713. It still needs to receive further positive news to enable it to challenge resistance at 1.0820 as a prelude to scaling the heights around 1.10.

Have a great day!

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Alan Hill

Alan has been involved in the FX market for more than 25 years and brings a wealth of experience to his content. His knowledge has been gained while trading through some of the most volatile periods of recent history. His commentary relies on an understanding of past events and how they will affect future market performance.