Easing the squeeze

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Easing the squeeze

The latest official headline figure for UK inflation, as measured by the Consumer Price Index (CPI), fell to 2.7% from 3.0%. This is lower than the 2.8% market consensus estimate and lower than the official inflation forecast of 2.9% by the Bank of England.

The shift in the inflation number has great significance because households have been bearing the brunt of inflation at a time when wage growth has failed to keep up. In what has been a painful period for living standards it now looks as if the squeeze may be about to ease.

Wages have been slow to respond to a much stronger labour market. We can see from the chart below that sluggish wage growth has been overtaken by fast rising prices. However, with the latest announcement of easing inflationary pressures the gap has at least narrowed.

On current trends, highlighted by the dotted lines below, wage growth is expected to shortly move back above inflation giving spenders a welcome boost after two years of being quashed in real terms.

Source: Bloomberg, March 2018

Inflation is the sustained annual increase in the general price level of goods and services in an economy, meaning an average basket of goods and services costing £100 in February 2017 has risen to a cost of £102.70 today. A fall in petrol prices alongside food prices rising more slowly than last year helped pull down inflation. In addition, the rise of the pound from its lows after the Brexit vote in 2016 has also helped to suppress the price of imported goods.

Wages, measured by weekly earnings inched up from 2.7% to 2.8% in January. Growth in regular pay (i.e. excluding bonuses) also picked up from 2.5% to 2.6%. Employment conditions continue to impress with 168,000 new jobs created in the three months to January meaning the consensus expectation of 84,000 new jobs was well and truly smashed. This gives reassurance that the weakening of the jobs market witnessed at the end of 2017 was a temporary soft patch. The unemployment rate is now back at 4.3% from 4.4%.

In conclusion, with inflation easing, higher employment and higher wages, there should be a positive knock-on effect across the UK economy. Consumers may spend more on discretionary items, consuming more goods and services, allowing businesses to hire more staff and pay higher wages, creating a virtuous cycle. This is all very encouraging. It also unravels the puzzlingly absent effect of wages not responding to lower unemployment. It now seems that the relationship is operating with a long lag.

With investing, your capital is at risk. Investments can fluctuate in value and you may get back less than you invest. Past performance is not a guide to future performance. Tax rules can change at any time. This blog is not personal financial advice.

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