Why is UK wage growth so strong?

The strength of UK wages is a puzzle for economists — and a growing problem for Bank of England policymakers.

Surging inflation, widespread labour shortages and a wave of public sector strikes drove growth in average nominal UK earnings to a record high of 8.3 per cent in the summer of 2023. Since then, the economy has stalled, vacancies fallen and employers have put the brakes on hiring. Productivity, the long-term determinant of wages, has been falling since 2023. 

Yet average earnings in the three months to January were still 5.9 per cent higher than a year earlier — and have been outpacing inflation for more than a year and a half. 

Bigger pay packets are a boost to household finances but also a worry for the BoE, which sees current rates of wage growth as inflationary, unless underpinned by better productivity. 

Understanding what is going on will therefore be critical to the outlook for interest rates. 

Is wage growth really as strong as it looks?

The BoE’s Monetary Policy Committee downplayed the latest official wage data as it announced its decision to leave interest rates unchanged at 4.5 per cent on Thursday. 

A 6.1 per cent increase in private sector average weekly earnings had been fuelled by some sectors where pay growth was often volatile, it said. Other indicators were in line with the BoE’s estimate, published in February, of underlying wage growth slightly above 5 per cent. 

But this still means wage growth is “at an elevated level and above what could be explained by economic fundamentals”, the MPC said. 

The MPC added that one of the two main risks it would focus on in the run-up to its May meeting was “the extent to which there could be more persistence in domestic wage and prices”. The other risk it flagged was of geopolitical tensions pushing the economy into a deeper downturn.

Will pay growth come down?

Wage growth does look set to slow over the coming year. Official data shows pay pressures moderating in the last couple of months. The BoE’s own surveys, and data collected by the research organisation Brightmine, suggest employers will give pay awards to existing staff of between 3 and 4 per cent in 2025. 

Some employers will squeeze pay awards by 1 to 2 percentage points to offset the impact of higher payroll taxes from April, the BoE’s agents found.

But Rob Wood, chief UK economist at the consultancy Pantheon Macroeconomics, said this would still likely leave earnings growth above 4 per cent on the ONS’ measure — too high to be consistent with keeping inflation on target at 2 per cent, in the absence of higher productivity. 

What’s driving it?

One possible factor is a series of big increases in the statutory minimum wage. This does not usually affect median earnings. But employers such as the retailer Next have warned of a “ripple effect”, raising wages for staff higher up the scale to make sure there are still incentives for progression. 

A change in the mix of jobs in the economy could also be part of the explanation. Data released on Thursday shows employment has fallen in the low-wage retail sector over the past year, while more people are employed in professional areas and in financial services. 

But Xiaowei Xu, senior research economist at the Institute for Fiscal Studies, a think-tank, said these factors could only explain “a tiny fraction” of the disconnect between pay growth and the state of the economy. 

A further possibility floated by BoE governor Andrew Bailey — that productivity growth might not be as dire as the official data suggests — does not convince economists. 

“As if,” Greg Thwaites, research director at the Resolution Foundation think-tank, wrote in a recent blog.  

Why is the Bank of England worried?

The big concern for the BoE is that something has changed in the structure of the UK economy, meaning that workers and employers are now adjusting to a “new normal”, where wages grow at 3.5 or 4 per cent a year, and inflation hovers closer to 3 per cent. 

“That would be more costly to change if it became entrenched,” Claire Lombardelli, BoE deputy governor, warned at the end of 2024. 

Wood argues that this is already happening and policymakers are “far too sanguine” about a marked rise in household expectations of inflation five and 10 years ahead. 

In the years leading up to the Covid pandemic, annual pay rises of 3 per cent became standard because people expected inflation to average 2 per cent over time, he noted. Now, “households expect the Bank of England to do absolutely nothing . . . and to allow inflation to run well above target forever”.

Why aren’t households spending? 

An additional puzzle is why real-terms wage gains are not yet boosting consumer spending. Official statistics show that both retail sales and overall household consumption remain below their pre-pandemic level, with people saving a historically high share of their income. 

Analysts say spending should pick up once households have rebuilt buffers that were depleted during the pandemic. But people still worry about rising food, energy and housing costs, threats of cuts to jobs and public spending, and talk of trade wars and rearmament. 

Sandra Horsfield, economist at the investment bank Investec, said the need for higher defence spending would be “unsettling” for UK consumers, as well as the threat of US tariffs leaving people “wondering how the [UK] general economic situation will fare”.