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Stubborn inflation is complicating central bank easing plans. The stickiness is largely in the services sector, where prices can be swayed by labour costs, which are still rising fast. We assess wage growth prospects for both Canada and the U.S. below. Canada“Assessing the health of the labour market from various angles is an important input into our monetary policy decisions… But, we continue to think that we don’t need a large rise in the unemployment rate to get inflation back to the 2% target.” — BoC Governor Tiff Macklem, June 24, 2024 The latest CPI reading was the first high-side surprise for Canadian inflation in 2024 and was a loud shot across the bow for those who believed that price trends would go quietly into the night. There was no single factor that drove the CPI three ticks above consensus, with ongoing pressure on rents, a snapback in food, a spike in recreation, and persistent pressure on a variety of services. While inflation has moderated tremendously from its 8% peak of two years ago, it has been stuck around 3% for most of the past year. Besides the relentless push from shelter costs, the other main factor keeping inflation somewhat sticky is lingering wage pressure. To be sure, this largely reflects workers trying to catch up with the inflation burst of the past three years. But, contrary to perceptions, real wages have managed to grow from pre-pandemic levels, as compensation has outstripped inflation since the start of 2020. Ultimately, without solid productivity gains, additional wage growth will translate directly into cost pressures, which will keep a fan on services prices. |
From that perspective, the good news for the inflation outlook is that the labour market is now much less tight than the extreme conditions of two summers ago. At that time, Canada’s jobless rate was at a five-decade low of 4.8% and there were a million vacant jobs. The unemployment rate has since forged higher to 6.2% and job openings have plunged more than 40%. This has lowered the job vacancy rate all the way back to pre-pandemic levels of 3.2% from a peak of 5.7% (Chart 1). The vacancy rate is an excellent leading indicator of wage increases. What stands out from the chart is that Canada’s job market never got as tight as the U.S. and is now closer to ‘normal’. In a word, the Canadian job market can no longer be considered tight—arguably it is now tilting the other way. |
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Another clear sign that the steam is coming out of Canada’s job market can be gleaned from the Bank of Canada’s own Business Outlook Survey (BoS). Every quarter, firms are asked whether they are facing labour shortages; the share reporting “yes” topped out at 46% in the middle of 2022—precisely as inflation was peaking and unemployment bottoming. That share has since dropped all the way back to 22%, which is below the long-run norm of around 30% (Chart 2). Not surprisingly, labour shortages also tend to line up well with wage increases, and particularly with what firms expect to pay. While expected wage hikes have cooled from more than 5% two years ago, they remain relatively lofty at just above 4%. Just ahead of the next rate decision, the Bank may be watching these metrics closely in the July 15 edition of the BoS. One reason that expected wage increases remain relatively high is that labour unrest is elevated, reflecting the drive to make up for past inflation. One measure of that unrest is the number of work stoppages and days lost to strikes (Chart 3). Over the past 12 months, there have been nearly 6 million person-days lost to job actions in Canada, in a workforce of just over 20 million people. While not a huge bite to the economy, these work stoppages are running at their highest level since the mid-1980s. Labour unrest is one of the (many) ill effects of high inflation—and it is perfectly predictable: employees want to be made whole for past inflation, while employers don’t want to get locked into paying large wage increases as inflation is falling. |
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So where does all of this leave the outlook for Canadian wage trends? Governor Macklem’s recent speech highlighted the reality that there are many different measures of wages, and they are sending somewhat contradictory signals. Note that one of the most widely followed wage readings—average hourly wages—just happens to be running the hottest (now at 5.1%). However, an average of eight different available wage metrics (including the four the BoC highlighted) gives a reasonably consistent signal—the 12-month trend has ebbed somewhat to around 4.5%, with the six-month pace slipping a bit below 4%. While down from a recent peak of more than 5%, even the shorter-term trend remains above the pre-pandemic norm of closer to 2.5%. And, with productivity growth very weak, unit labour costs in the private sector were running above 4% y/y in Q1, or double what’s consistent with 2% inflation. Given the emerging slack in the job market, wage trends are likely to gradually fade further. But, in the meantime, underlying services inflation is also likely to remain sticky, producing some occasional high-side CPI surprises similar to the latest result, and forcing the Bank to proceed very cautiously on the rate-cut front. The upside of the persistence of somewhat firmer wage trends is that the Bank struggled to get core inflation up to its 2% target in the decade before the pandemic—CPI ex food & energy averaged just 1.6% in that period, even with extraordinarily low interest rates. That’s unlikely to be an issue in the years ahead. |
United States |
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“Overall, a broad set of indicators suggests that conditions in the labor market have returned to about where they stood on the eve of the pandemic, relatively tight but not overheated.” — Fed Chair Jay Powell, June 12, 2024 Wages and inflation often move together (Chart 4). When demand is strong, businesses try to pass higher wages onto customers, which can spur workers to seek a bump in salary, begetting another round of cost passthrough. The flipside is that as inflation cools, workers become less demanding. So, it’s not surprising that wage growth has moderated alongside inflation in the past two years. While the various wage measures tell slightly different stories, one of the more respected, compiled by the Atlanta Fed, suggests wage growth has unwound about half its post-pandemic rise (Chart 5). Still, the yearly rate is above 4% and a full percentage point higher than in 2019. Growth in the employment cost index (at 4.2%) is also showing stickiness, retracing only a third of its increase. Still, at least one business survey points to further ebbing ahead. The moderation in wage growth reflects some loosening in a historically tight jobs market. The unemployment rate has climbed to 4.0% from a half-century low of 3.4% in April 2023. That’s only slightly below the median Fed policymaker’s estimate (4.2%) of the long-run jobless rate deemed consistent with price stability. In addition, the number of job vacancies per unemployed person has fallen to 1.2 after peaking at a record-high 2.0 in March 2022. It’s back to pre-pandemic levels, though still double the long-run norm due to some mismatching of job requirements and worker skills. A similar message is revealed when comparing available labour supply with current demand (Chart 6). The record excess-demand gap of more than five million workers in March 2022 has all but vanished. Our in-house measure of the amount of slack in labour markets (derived from sixteen monthly series) suggests the degree of tightness has been easing almost since the day the Fed started lifting rates. While the market is still somewhat tighter than normal, conditions mirror those before the pandemic, when inflation was relatively steady. It’s not just worker shortages and wage growth that matter for inflation. The urge to pass through rising wages depends crucially on productivity. If the two rise together, profit margins should remain stable. In fact, the ratio of U.S. corporate operating profits to sales is still above normal. This is partly because faster productivity has more than offset higher compensation (Chart 7). As a result, unit labour costs are mostly consistent with the 2% inflation target (see Chart 4 again). If productivity growth remains strong, there would be no need for wages to decelerate to restore price stability. However, productivity has been running faster than normal, so some slowing is likely. In this case, wage growth would need to step back further. Bottom Line: While labour markets in the U.S. may need to loosen a bit further, labour costs in both countries appear to be headed in the right direction to tame inflation, paving the way for a gradual easing of monetary policies in the year ahead. |
