There are two reasons for this.
One is that we're starting to see the impact of low price inflation. The level of wage inflation today depends upon pay settlements which were agreed up to 12 months ago. This means that if we get a shock to price inflation - as we did when oil prices slumped last autumn - wage inflation will not immediately respond simply because it reflects old pay deals. For a while, therefore, real wages will rise strongly. Eventually new pay settlements will reflect the lower level of price inflation, and so nominal wage growth will fall towards the lower level of price inflation. Low inflation can only raise real wages temporarily. Eventually, the boost gets clawed back. This is what is now happening.
Secondly, workers' bargaining power is not as strong as you might infer from the fact that the unemployment rate, at 5.3 per cent, is at its lowest since early 2008. This is because the official unemployment rate greatly understates the excess supply of labour. As well as the 1.75m unemployed, there are almost 2.3m people who would like a job but are classified by the ONS as 'economically inactive': these include some of the retired, home-makers and students. And 'inactivity' is a misnomer. In the third quarter, 541,000 'inactive' people moved into work. That's 23.3 per cent of all the 'inactive' who wanted a job. This means that the 'inactive' are almost as likely to move into work as the unemployed, 27.6 per cent of whom did so in the third quarter (Q3).
With the supply of labour so high - and I'm not even mentioning migration - the natural result is lowish wage growth.
So, what sort of wage growth should we see? A key indicator here is labour productivity. On average, we'd expect real wages to rise in line with this: if the balance of class power favours workers, wage growth might be high, and if it favours employers it will be lower. In Q3, productivity was 1.6 per cent up on a year ago, although there are signs of it picking up: it rose by 0.6 per cent during Q3. This implies that real wages might not rise much more than 2.5 per cent - which is less than we saw earlier this year.
What's more, if nominal wage growth exceeds productivity growth by less than 2 per cent, then we'd expect to see price inflation below its 2 per cent target, unless non-wage costs rise significantly or profit margins expand. This means that if productivity continues to grow at the rate it did during Q3, wage growth of even 4 per cent might be compatible with sub-2 per cent inflation.
All this has two implications. One is that we could see a slowdown in consumer spending growth. This would be the obvious effect of lower real wage growth, especially combined with slower employment growth (which would be the immediate effect of faster productivity growth) and a likely cut in tax credits next year.
Secondly, if wage growth doesn't threaten the inflation target then a rise in interest rates will be a long way off.
