As recently as March of this year, wage growth remained elusive in this cycle. Fast forward six months, and wage growth has picked up in a synchronous fashion across the G3 U.S., the euro area and Japan standing at multi-year highs in all three geographies.
With wages finally gathering steam, it’s natural to worry whether they will lift inflation meaningfully above central banks’ goals or dampen corporate profitability. believe that two key parameters—the ‘normal’ level of wage growth and unit labor costs—indicate that the starting point of wage growth is not yet a cause for concern. Wage growth across the G3 remains below normal levels, but the gap has narrowed: Only when nominal wage growth outpaces the rule of thumb for normal wage growth do the trend of labor productivity growth plus central banks’ inflation goal do inflationary spillover and corporate profit pressure occur. Over the past six months, the gap between actual and normal wage growth has narrowed by 14bp, 66bp and 124bp, respectively in the U.S., euro area and Japan. Currently, the gap in the U.S., euro area and Japan now stand at 50bp, 60bp and 110bp, respectively.
The recent improvement in productivity growth has held unit labor cost growth in check: Unit labor costs (which measure the average cost of labor per unit of output and are calculated as the ratio of total labor costs to real output) remain below prior peaks in the U.S. and Japan. In the euro area, they are approaching a nine-year high, thanks to the conclusion of recent rounds of wage negotiations, but they should moderate going forward as the impact of these negotiations drops out.
Labor markets do have some room to strengthen before challenges emerge and that is why this is not an immediate risk. However, it may materialize later in the cycle and is a key risk. The next few months’ data points on wage dynamics will therefore warrant close monitoring.