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Inflation's a continual problem. Wages are rising just as inflation peaks. The big question... Will pay hikes fuel another round of price increases and what could that mean for markets?

This is one of many times when I don't envy economists. Their job is to forecast the future, back that up with rigorous data, historical models and draw conclusions.

Few economists are rewarded for thinking outside the box, so they usually don't. Anecdotal evidence doesn't figure too highly. Nor does 'common sense' analysis.

Often there are good reasons for this. Hard data can be more reliable than our flawed human musings and bias-fuelled observations.  

Fortunately, we're not economists. So we're free to speculate...

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Wages haven't kept pace with inflation over the past year

Economists call this negative real wage growth:

Basically, worker earnings don't buy what they used to. Even as wages rise, if those pay increases don't match inflation, purchasing power is being eroded.

However, there's a big problem with this sort of aggregate data. Few people really experience the inflation reported in the consumer price index.

Inflation in the real world isn't as linear as economists would like. Far from it.
Paul Donovan, who's written an entire book on inflation, explained this early in 2022.

Consumer prices do not represent everyone’s spending power
US households that do not drive a car are experiencing an inflation rate half that of the headline, for instance
The spending power of a large minority of households is significantly better than consumer price inflation suggests

But workers do notice rising prices. So they ask for more pay. Some companies even pro-actively offer higher wages to keep employees happy.

Economists say this can lead to a wage price spiral. Some kind of shock (like a global pandemic) causes an initial price spike, then the spiral gets underway:

Wage price spiral inflation

This isn't exactly how it works. As usual, reality is far messier than the models. It's a decent framework for understanding the forces at play though.

Companies have definitely raised prices. In some cases, those prices have increased company profits. Other times, price jumps have simply maintained profits.

Negative real wage growth has been a genuine problem for employees.

Nevertheless, workers are fighting back globally and demanding pay rises. This thread lays out a load of instances. A selection of those are highlighted below.

  • Germany's IG Metall union agreed a below-inflation pay deal in a powerhouse region, setting the benchmark for 3.9 million metal and electrical sector workers nationwide. (5.2% pay rise in 2023 & 3.3% rise in 2024)
  • Austrian metal workers secured a pay rise on average of more than 7%. Due to the way the pay rises are structured, the lowest earners receive an effective pay increase of 8.9%.
  • Volkswagen agreed a two-year wage deal for workers at its western German factories, offering around 8.5% higher pay for around 125,000 of the company's employees.
  • ScotRail have negotiated with the RMT union, and agreed that wages will rise by 7.5% for staff such as conductors and ticket examiners. There will also be an 8.5% increase for lower-paid workers.

Amazon faces strikes in 40 countries around the world, as warehouse workers campaign for higher pay and better conditions. The campaign has been organised by Make Amazon Pay

Workers at BHP's Escondida copper mine in Chile have rejected the latest deal, truckers in Korea are striking for the second time this year, and rail workers in the US are set to strike on December 9th

That's just a selection. It's a truly global phenomenon and will likely continue for some time. Maybe several years according to ECB chief economist Phillip Lane

the staggered nature of wage setting means that the adjustment of nominal wages to the cumulative increase in the cost of living will play out over several years.
this type of time-limited catch-up phase should not be mis-interpreted as indicating a permanent shift in nominal wage dynamics

One of the reasons we referenced the Goldman Sachs research in this article is because the second order effects of inflation are hard to predict.

This chart's for the US, although it could apply anywhere, and illustrates the simple idea that as inflation falls and incomes rise, there's more money left over for discretionary spending (red diamonds on the chart):

Which, in theory, could open the door to another round of inflationary pressures. Perhaps not as high as we've seen so far this year...

But enough for a second spike just as central bankers think they've got inflation under control? Maybe.

Or simply enough of an income jump to keep inflation running persistently above target for longer? If there's another spike in energy prices, all bets are off.

Inflation is forecast to fall in an orderly fashion over the next year or two. The labour market's simply too strong to take it for granted. Even as the tech layoffs mount up (71,443 in the US so far in 2022) 👇

Other sectors keep on hiring...

EY (Ernst & Young) is on track to hire around 220,000 people in the twelve months to July 2023 according to Bloomberg.

Bottom line. There are still plenty of jobs to fill. Workers are generally being granted pay rises, and companies are likely to keep pushing price hikes if they can get away with it.

Inflation may have peaked, but it's not over yet.