RPI tax and prices index
The UK RPI Tax and Prices Index (TPI) measures how much the average person’s gross income needs to change to purchase the RPI basket of goods and services, allowing for income tax and national insurance.
At the end of November, TPI was running at 5.2 per cent year-on-year.1 However, average earnings are currently growing at around two per cent per annum, meaning that real wages (in this case, average earnings divided by TPI) are being squeezed. In fact, the annual growth rate of real wages has been negative since the first half of 2008, as employees have taken pay cuts and worked part-time in return for keeping their jobs, as inflation has been persistently higher than expected and as taxes have risen – the latest being VAT on 4th January.
If earnings growth continues to be negative in real terms, then the outlook for private consumption (worth around 65 per cent2 of GDP) could be lacklustre.
This all rests on the assumption that workers cannot protect their real wages. The Bank of England’s Monetary Policy Committee (MPC) is betting on this, and hoping that inflation will fall, reasoning that the labour market is too weak for wages to accelerate. It has been unwilling to jeopardise the recovery so long as the risk that persistent above-target inflation out-turns don’t become ingrained in inflation expectations.
However, the Bank’s fourth quarter inflation expectations survey, conducted in November, showed a further rise in the general public's forecast of inflation, with the median expectation for inflation on a one-year horizon pointing to a rate of 3.9 per cent by the end of 2011, compared with 3.4 per cent three months earlier; in two years' time inflation was predicted to be 3.2 per cent, versus 2.9 per cent previously; and in five years' time expected inflation was 3.3 per cent, versus 3.2 per cent previously.3 This is at odds with the MPC's claim that inflation expectations remain anchored around its 2 per cent target – so its strategy of turning a blind eye to persistent inflation overshoots may have done some harm to its credibility.
This will be tested soon – over 60 per cent of wage settlements in the UK are conducted during January (mainly private sector) and April (public and private sector).4 If workers are unable to negotiate significant wage growth – quite likely, given cuts in the public sector – then the course of TPI would seem to be critical for the path of UK consumption. But, paradoxically, lower real wages can be good for the economy, in so far as they boost UK competitiveness and employment (employers use more labour relative to capital as labour becomes cheaper – people are ‘priced’ back into employment).
Furthermore, the erosion of household purchasing power is good news for the MPC: wages account for some 70 per cent of corporate costs,5 which are ultimately borne by the end consumer, so weaker wage growth could result in lower prices. Indeed, the weakness of real average earnings growth is one reason why there is no immediate need to hike interest rates to stave off inflation.
1. Source: National Statistics Online.
2. Deutsche Bank, 7th January 2011.
3. Bank of England/GfK NOP Inflation Attitudes Survey November 2010.
4. Deutsche Bank, 7th January 2011.
5. Commerzbank, 7th January 2011.
Author: James Codrington
James Codrington heads the charities team at Barings and is a member of the targeted Return Group.
He joined Barings in 2002 and has 14 years' investment experience.
He has an MBA in Mordern History from Oxford University and is a regular speaker at charity events.
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