UK wage growth exceeds expectations, job market shows resilience

The data released by the Office for National Statistics (ONS) on Tuesday showed that wages excluding bonuses increased by 5.9% year-on-year in the fourth quarter of 2024, higher than the 5.6% in the first three months and in line with market expectations. This growth rate reflects that corporate salary expenditures are still on the rise, despite the government announcing an increase in employer payroll tax and minimum wage standards.

Meanwhile, the UK job market has performed better than expected. The number of employed people receiving salaries in January increased by 21000, compared to the overall decrease of only 20000 since the Chancellor of the Exchequer Rachel Reeves announced the increase in payroll tax in October last year, far less than the market's previously expected decrease of 30000.

The resilience of the job market has exceeded expectations, which is a complex signal for the central bank. "British economists point out that although business surveys have predicted large-scale layoffs in the labor market similar to those during financial crises, official data has not yet reflected this trend.

The data shows that the layoff rate in the most recent quarter was 3.9 per thousand people, slightly increasing, but still declining year-on-year, indicating that companies remain cautiously optimistic in the context of increasing labor costs.

Rising wages drive up inflation, leading to cooling expectations of central bank interest rate cuts

The sustainability of wage increases poses a new challenge to the Bank of England. The private sector wage growth rate reached 6.2%, slightly lower than the central bank's forecast of 6.3%, but still at a relatively high level, which may continue to push up service sector inflation.

The Governor of the Bank of England, Andrew Bailey, has stated that "wage growth remains one of the core factors in maintaining high inflation, and wage pressures have not significantly slowed down, which may affect monetary policy adjustments

Another key data that the market is concerned about is that the inflation rate in the UK is expected to rise to 2.8% in January, the highest in the past 10 months, which will further affect the path of interest rate cuts. The Bank of England has previously warned that although the market expects wage growth to slow down to 4% by 2025, this level is still above the safe range to achieve the 2% inflation target.

The impact of government tax adjustments on enterprises

The key issue currently being focused on by the Bank of England is how businesses will respond to the upcoming increase in National Insurance Contributions. The market expects companies to respond in two ways:

1. Transfer higher salary taxes to consumers, further pushing up prices and sustaining inflationary pressures.

2. Control salary growth and lay off employees to alleviate the inflation risk brought by the labor market.

The Bank of England pointed out at its February policy meeting that in the short term, businesses may be more inclined to pass on costs to consumers, which means that inflation may fall slower than expected.

In addition, the UK Office for National Statistics is accelerating the improvement of its labor market survey methods, as the accuracy of employment, unemployment, and economic activity data has been questioned due to a decrease in survey response rates over the past year. This adjustment may not be fully transitioned until 2027, which also increases the uncertainty of policy-making.

The pound rises, and the market re evaluates the timing of the Bank of England's interest rate cut

Affected by strong wage growth and employment data, the pound rose against the US dollar in the short term, reflecting a cooling of market expectations for the Bank of England's interest rate cuts.

The market had previously predicted that the Bank of England may initiate interest rate cuts in the second half of 2024, but the latest data suggests that inflation and wage growth are still at a high level, which may force the central bank to maintain a longer period of high interest rate policy, thereby supporting the pound.

The resilience of the job market and rapid wage growth make it more difficult for the Bank of England to adopt loose policies in the short term, which enhances the attractiveness of the pound, "said HSBC's foreign exchange strategist.

However, there is still uncertainty in the market. If the UK economy slows down in the coming months or companies start laying off employees to cope with higher payroll tax burdens, the pound may face downside risks. In addition, the monetary policy dynamics of the European Central Bank and the Federal Reserve will also have an impact on the trend of the pound.

Overall, in the short term, the pound may be supported by lower expectations of interest rate cuts from the Bank of England. However, if inflation slows down or the job market deteriorates, market bets on interest rate cuts may reignite, and the pound may face downward pressure.

Editor's viewpoint:

The strong performance of UK wage and employment data has boosted the pound, while reducing market bets on a rapid rate cut by the Bank of England. However, the future trend of the pound still depends on the outlook for economic growth, how businesses respond to salary tax adjustments, and the monetary policies of major central banks around the world.

In the short term, the Bank of England may maintain a cautious stance and avoid premature interest rate cuts to ensure that inflation truly falls back to the target range. The pound may maintain its strength in the short term, but once there are signs of weak economic data, the market may readjust its expectations for the Bank of England's policies, at which point the pound may face new volatility risks.