UK to see first real pay rise since 2007, but don’t expect a return to boom time wage growth says EY ITEM Club

23 February 2015

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  • Wages set to increase by 1.9% this year and accelerate thereafter, but unlikely to return to pre-crisis rates before 2018
  • Continued growth in the labour force will help contain wage growth
  • Unemployment expected to fall back to 2008 levels over the next three years, dropping to 5.2%
  • Productivity forecast to finally see a recovery, growing by 1.7% a year from 2016 to 2018

2015 should see the UK’s workforce enjoy the first increase in real pay in eight years, according to EY ITEM Club’s special report on the labour market published today.

Negative inflation for part of this year and a steady pickup in nominal wage growth to 1.9% will deliver the first pick up in real earnings since 2007. Looking beyond 2015, the EY ITEM Club expects nominal wage growth to continue to accelerate but, underpinned by  continued strong growth in the supply of labour, will remain short of the pace achieved in the decade prior to the financial crisis. As a result, nominal wages are forecast to grow by 3.7% in 2018, still 0.7% short of the pre-crisis average.

The EY ITEM Club expects strong growth in the workforce to continue to be the dominant feature of the UK labour market over the next four years. The report forecasts that the workforce will expand by over 1.2 million people between 2014 and 2018, growing at an average rate of 0.9% a year.

According to the report, immigration into the UK will continue to support the inflow of labour. However, it is likely to be at a slightly slower pace to recent years, with improving economic conditions, particularly in the Eurozone, reducing the incentives for workers to move from their own countries.

Another boost is likely to come from further increases in the number of older people remaining in the workforce, with improving health and deficient levels of pension saving remaining important drivers. The EY ITEM Club says that the number of people over 50 in work or looking for work has increased by 1.125 million since the end of 2009, representing 90% of the increase in the total workforce. Looking ahead, an increase in the State Pension Age for women from 62.5 to 65 by the end of 2018 is expected to add another 125,000 people to the UK labour market over four years. In addition the report also points to the prospect of further cuts in public sector payrolls and the number of people receiving welfare support after the election.

Martin Beck, senior economic advisor to the EY ITEM Club comments: “Real earnings have fallen by nearly 10% since 2008, but workers will finally see more money in their pockets this year. However, this is not a normal recovery. The move towards later retirement and the huge increase in the size of the workforce has depressed real wages as workers have priced themselves into jobs. We don’t expect a return to boom time wage growth any time soon. Employment will continue to be strong, but wage growth will remain relatively modest.”

Tom McCabe, Human Capital Advisory Partner at EY comments on the implications for businesses: “This growing diversity of the workforce means companies and their HR functions have to manage a labour pool that looks very different from before the financial crisis.  As the workforce becomes more diverse, so do its motivations and priorities.To manage this diversity successfully, companies will have to radically change their employee offer with reward structures, training, and incentives all geared to meeting a wider range of needs and aspirations.”

Robust employment will lead to the shortest dole queue since 1973

The EY ITEM Club expects employment to increase by 1.2% a year in the three years to 2018. At the same time the unemployment rate will continue its downward trajectory and return to its pre-crisis level of 5.2% in 2018. The claimant count, according to the report, is likely to fall even further, taking the number of people claiming job seekers allowance down to just 1.6% of the workforce by the end of 2018, the lowest rate since 1973.

Alongside robust job creation, the EY ITEM Club expects a gentle acceleration in productivity growth, as the financial sector returns to health and stronger demand allows firms to better utilise workers. Productivity is forecast to increase by an average of 1.7% between 2015 and 2018, up from just 0.3% in 2014.

Impact on the economy

The EY ITEM Club says that the gradual recovery in workers’ pay packets will ‘have important implications for the UK economy’. According to the report it will prompt the Monetary Policy Committee to raise interest rates in an equally gradual fashion, with the first hike in interest rates expected in early 2016. Meanwhile, this relatively muted recovery in pay could mean bad news for the Government’s deficit reduction plans as it holds back growth in income tax receipts.

Beck concludes: “A gradual pick-up in wages will translate into good news for the economy through a boost in consumer spending. A pay rise for the UK’s workforce also offers some bonuses for the Government by supporting income tax receipts. But, with the pace of earnings growth continuing to lag behind pre-crisis norms, workers’ pay is unlikely to be the revenue raiser that it has been in the past.”