Much like the British summer, make the most of the earnings boom while it lasts  


Ahead of the summer budget early next month, the Chancellor may be hoping for some positive headlines in the employment statistics due on Wednesday.  When it comes to earnings, he’s sure to be rewarded.

Our analysis suggests that real regular pay will top 2.5 per cent year-on-year growth in this week’s numbers (covering the three months to April this year), up from 2.1 per cent last month. This would be the highest rate since before the crash, and one experienced only a handful of times since 2002. Private sector pay looks set to be even stronger – at least 3 per cent real growth.

This assessment is based on our new prediction for the headline rate of earnings growth, which we’ll be keeping updated to cast one or two months ahead of the published data. Coming up with such a short-term prediction isn’t rocket science: because the headline growth figure is based on a three-month average we have much of the information we need already and can make some educated guesses at the unknowns (see the methodological note at the end for details of our approach and current prediction). Nonetheless we think this near-term view is worth talking about to help us assess current levels of slack in the labour market, and to offer insights on the medium-term prospects for real pay.

So what to make of our ‘seasonably warm’ forecast for Wednesday? Real pay growth well above the pre-crisis trend of 2 per cent will be a cause for celebration in parts of the media. And make no mistake pay growth at this healthy rate is very welcome. But we also need to keep it in perspective and not go over the top.

First, it’s worth reiterating how long we’ve been waiting for this kind of a rebound. Almost everyone has expected wages to pick up long before now, particularly with evidence of tightening slack and nascent signs of business and worker confidence. It’s been a wage recovery long-postponed. The fact that even this ‘mini-boom’ has been such a long time coming remains a real cause for concern.

Second, we must continue to highlight the role inflation of negative 0.1 per cent is playing.  The underlying nominal pay growth figure – although likely to be at its highest level since early 2009 – is still a way off its pre-crash average of around 4 per cent. With our ‘two-months-ahead’ prediction indicating that nominal pay growth may not build all that much further in the short term, even a modest increase in inflation would return us to fairly weak real wage growth.

In this light, it is concerning that in its latest Inflation Report, the Bank of England forecasts nominal pay growth in the final quarter of this year to be no higher than the figure we think will be released on Wednesday. Combined with the Bank’s expectations for rising inflation, that would represent a return to very slightly below-trend real pay growth. If this is our rebound, it might well be short-lived.

So if the ‘mini-boom’ we expect to see celebrated this week turns out to be just that, what of the longer-term prospects for pay? As we (and many others) have argued before, long after inflation has moved back into more normal territory, it is productivity growth that will determine the extent to which economic recovery feeds through to pay packets. Buoyed by Wednesday’s good news, it is to our persistent productivity puzzle that the Chancellor’s attention ought to turn.

        Methodological note: The Resolution Foundation’s regular pay growth prediction
To remain robust, the Office for National Statistics’ (ONS’s) headline nominal pay growth figure is based on a three-month average. For example, last month’s wage growth figure compared average pay in January, February and March 2015 with the same three months last year.
So, given that the ONS release the full data as well as the headlines each month, we already know five out of the six figures used in next month’s calculation. We only need to guess how much average pay for April, in this case, will differ from March.
We can’t of course, pinpoint exactly what that answer will be. But we know, for example, that there has never been a single month change greater than around £3 or less than minus £2. Together with the known figures for the other months, that alone is enough to do a simple prediction of an upper and lower bound for headline pay growth next month.
In fact, we use a more complex model to better predict a likely range. This incorporates the historical prevalence of different-sized changes in pay from one month to the next, the state of the labour market, average pay growth over the past year and last month’s change. These ‘controls’ each make our model a bit more accurate.
We use a 75 per cent confidence interval for our central prediction, meaning that (assuming no subsequent revisions to the data we use) the actual value would fall within our range three times out of four (or nine times out of ten if we round to the nearest 0.1 per cent).
The fact that the ONS frequently makes small revisions to previous months’ figures throws a potential spanner in the works. We deal with this by factoring in the biggest revisions we have previously experienced and re-running our model. This gives us a ‘wide’ prediction range in which the actual value would lie 75 per cent of the time even given the most extreme possible impact of data revisions. Looking at previous months and years, it appears that the actual value just about always lies within this wider range.
As well as predicting the next headline growth figure, we use the same approach to cast two months ahead. The ranges we give are wider in this case because there are more unknowns and therefore more uncertainty in the modelling.
The figure and table below detail how our prediction would have fared over the years, and our current forecast. We plan to publish these on a monthly basis, as well as exploring whether and how we can increase the accuracy and precision of our modelling.