Wage growth has been slowing sharply since Rachel Reeves’s Budget tax raid – Simon Walker / HM Treasury
Rachel Reeves once said she would “wince” when looking at her bank account. It’s a familiar tale for millions of Britons, but has been made easier recently thanks to surging pay rises.
Yet all that now looks to be over, with booming salaries increases running out of steam – and the Chancellor herself is to blame.
Just as pay packets started creeping back, gradually repairing the damage of the cost of living crisis, bosses began tightening their purse strings again.
Pay growth has slowed from the peaks of more than 8pc in 2023 – when workers were scrambling to regain spending power lost to soaring inflation – to below 6pc now. The annual pace will slow further to 3.5pc in a year’s time, the Bank predicts, marking the weakest increase in wages since the pandemic.
Company surveys make clear it is the Chancellor’s policies that are at fault. Reeves’s £25bn raid on employers’ National Insurance Contributions (NICs), which came into force last month, is hammering businesses.
The tax raid increases the rate of NICs from 13.8pc to 15pc, and reduces the earnings threshold at which it kicks in from £9,100 per year to just £5,000, meaning those who employ low-paid and part-time workers are particularly hard hit.
Bosses are nominally the ones who pay the tax, but in practice the cost is also shared with workers through lower wages, as well as customers, who pay higher prices.
“In response to NIC changes some firms say they are likely to offer pay settlements of one to two percentage points less than otherwise. All employers are looking to try to mitigate higher costs somehow,” said the Bank of England in its Monetary Policy Report on Thursday.
That represents a shift from the initial assumption that, given the tight jobs market, most of the tax rise would be paid by consumers through higher prices, says Sir Dave Ramsden, a deputy governor of the Bank.
“In the autumn when we were talking about this, there were lots of discussions that this was going to be inflationary,” he says. “There still will be some element of pass through that margin, but what our agents are telling us is that, actually, it will be pushing down on wages relative to what they would have been.”
That is if you have a job at all. The Bank notes that “firms have cited April’s increase in employer NICs as a reason for weakness in employment growth”.
This is particularly severe for small businesses, according to the National Institute of Economic and Social Research.
“A large part of the heat, whether you look at NICs or the national minimum wage, falls on small and medium-sized enterprises,” said Arnab Bhattacharjee, at the Institute.
“Plus there is something that is also anticipated over the summer, which is labour market reforms – small businesses are tightening their belts now in anticipation of that.”
It is plausible that bursting the pay bubble comes with a silver lining. The Bank of England had worried that the strength of the jobs market and the rapid pace of pay rises threatened to embed more inflation in the economy, particularly in services prices.
That stopped officials from cutting interest rates more rapidly, because Andrew Bailey, the Governor, and his colleagues felt the need to keep a lid on inflation.
Despite much of that pressure in the jobs market dissipating, the NICs raid is still going to add to inflation.
The Bank of England expects the pace of price rises to accelerate from 2.6pc now to a peak of 3.5pc in the third quarter of the year – firmly above its 2pc target.
Without the impact of the National Insurance increase, price rises would peak at more like 3.3pc, which would be a less worrying figure.
Once upon a time, the Bank would have been comfortable “looking through” a relatively small and temporary rise in inflation which, in this instance, is largely driven by energy prices as well as other costs like water bills and council tax.
Unfortunately, policymakers have to be more cautious now because of the awful experience of the cost of living crisis.
They fear that families are now on a hair trigger for signs of another wave of inflation.
“Survey measures of household inflation expectations had risen further in recent months, perhaps suggesting that households had become more sensitive to inflationary pressures, having recently experienced very high rates of inflation in 2022,” said the minutes of the MPC’s meeting.
When families expect higher inflation, workers demand higher pay, leading in turn to higher costs for businesses and higher prices in a self-fulfilling spiral.
Similarly, when businesses anticipate higher costs they can seek to increase prices in anticipation, with similar consequences.
As a result the Bank has to keep rates high to show policymakers’ determination to stop another round of price rises.
Perhaps rather ironically, it is Donald Trump’s trade policies that are poised to lower inflation in the UK, opening the door for more rate cuts.
The most critical impacts so far come from energy prices and from the prospect of trade diversion.
Global oil and gas prices have plunged as traders fear a global economic slump.
That has slashed the cost of filling a car at the forecourt, raising hopes that Ofgem will be able to cut its energy price cap in the summer and reduce household bills.
That should help limit the peak in inflation later this year to around 3.5pc – still above the Bank’s 2pc target, but not as far above as the 3.75pc which officials had predicted in their last set of forecasts in February.
Meanwhile, Chinese goods made for the American market have to seek buyers elsewhere, driven away from the US by the 145pc tariff imposed on most goods crossing from the world’s second-largest economy to the first.
China’s export prices are expected to fall by around 10pc, the Bank of England estimates, indicating British businesses and shoppers could soon be flooded with discount goods.
That is handy for those still reeling from the cost of living crisis, if less welcome for domestic manufacturers trying to compete with the tide of imports. Products from other countries may also sweep into the UK, if on a less dramatic scale.
In most instances, Trump has suspended his biggest tariffs for 90 days, limiting the tax on sales into the US to 10pc, with cars, steel and aluminium at a higher 25pc.
It means that inflation should fall back to the 2pc target at the start of 2027, not the end of that year as had been anticipated just a few months ago, giving the Bank space to trim borrowing costs.
That, at least, might provide some relief for workers if lower mortgage payments help them cope with underwhelming pay rises.
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