Wage growth in a low demand environment.

Wednesday, 20th February 2019 07:47 - by Shant

As is now widely acknowledged, global growth is looking a little fragile at the moment - to put it mildly.  Front and centre of investors' minds is the slowdown in China, and this has stoked fears that what has been a major driving force in worldwide growth, could now start to unravel as many anticipated it would. 

Growth rates may be showing a GDP rate of 6.0%, but this is being viewed upon with a healthy dose of scepticism.  Infrastructure spending has been the key component to prosperity in China, but the wheels are coming off the bus and the inevitable restructuring of the economy towards internal consumption will face a period of adjustment, which naturally has implications for the developing economies.  

Naturally, exporting nations, such as Australia, Japan, and Europe are more vulnerable in the current climate, and the US is also in the mix.  As we saw last week, both import and export prices dropped significantly, and only today, we saw the current account in Europe contracting to a notable degree and the outlook is not looking any better.  

However, there is another factor which may start to come to prominence for developed nations, and we point to the US and UK specifically.  Wage growth in both countries is starting to pick up, with the annualised rates currently around the 3.5% mark.  In both cases, and for different reasons, skilled labour shortages will likely have continued upward pressure on wages, with companies now facing the prospect of not only having to pay up for the best staff but increasing remuneration in order to hold onto their existing talent.  Productivity is at stake here, and clearly hiring managers will be under pressure to 'get the best', but the current dynamic suggests they will have to pay up.  

Human capital is a substantial component of many companies in the US and the UK - given the heavy composition of services industries, and these higher costs will start to impinge on profit margins.  In a world where demand is light, passing on these costs to the customer is going to be a 'tricky business' and as some of the inflation data is showing, this is not an environment where price pressures can or indeed are, being fed through.  Core inflation in the US is still a healthy 2.2%, but in light of the tax cuts last year and a bumper year for the economy, one would have expected a stronger impulse feeding through to prices, though as many Fed members have said, the threat of an inflationary overshoot are slim and I would tend to agree with them.  

We saw a sharp rise in inflation in the UK due to the Sterling collapse post-Brexit, but despite a short-lived recovery, CPI rates have been well contained, despite a lower exchange rate again. Indeed, core inflation in the UK is currently below the 2.0% mark, suggesting there is even less incentive to pass on 'higher costs'.  Consumer spending figures can be erratic - as we have seen in the US after the weak numbers in December - though January in the UK was a strong month, but can it last?  Whether it can or not is perhaps missing the point, of indeed the focus of this article.  Companies are and will struggle to pass on higher costs in the current economic environment, so higher wages are not necessarily the shining light for everyone - certainly not those who are forced to pay them out to keep their enterprises on an even keel.  

This is just another dynamic one has to look out for at present, and as above, service companies - of which there are many in the UK - are naturally more susceptible than others.  Yet another headwind to consider! 

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.