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Is UK heading for a wage explosion?

LONDON: Good news about an economy is almost never greeted without doom-laden warnings about something or other from economists.

In this case, the fact that unemployment in Britain has fallen to a 20-year low of just 4.0 percent of the workforce, while apparently a clear cause for national celebration, is making economists fret that it could push earnings and prices up and mean interest rates may have to rise further.

The announcement of inflation-busting pay awards for nurses and doctors by Prime Minister Tony Blair this week, and the fear that many people in the private sector are getting large pay rises, has only added to the concern. But there is also furious debate in the economics fraternity not just about whether pay and overall earnings are set to surge but whether that would cause inflation anyway.

In many ways the battle lines are drawn between those arguing that Britain's economy is in a new era where inflation is less of a danger than before and those who see in falling unemployment, rising house and equity prices the early signs of a classic inflationary spiral.

Certainly, a glance at the average earnings data released on Wednesday would suggest there is already trouble brewing.

The Office for National Statistics said earnings growth in the three months to November was 4.9 percent on a year earlier, well above the 4.5 percent the Bank of England has said is consistent with its target of 2.5 percent for core inflation. The other two percent is an assumption for productivity growth.

But the figure was unchanged from the previous month and the series has actually been fairly steady for several months.

And, argues Robin Marris, Emeritus Professor of Economics at London University's Birkbeck College, if highly erratic bonus payments are stripped out, core earnings growth slowed to 3.6 percent from 3.8 percent in October and 4.8 percent a year earlier.

"I can't see any change in the trend in these figures. And pay settlements are going nowhere," he said.

Independent pay settlement data -- which excludes the bonuses and overtime included in the earnings data -- have suggested that most pay deals have been steady in the 2.5-3.0 percent range for a long time, hardly a runaway boom.

Marris has also long disputed that bonuses are inflationary, saying they are usually related to profits made some time previously, do not add to firms' costs, and are one-off in nature.

There's also the question of the 2.0 percent productivity growth assumed by the BoE in its calculation of the 4.5 percent comfort zone for earnings growth.

Many economists argue that productivity, particularly in the country's dominant services sector, is being under-measured and is actually growing quite strongly. Some members of the BoE's Monetary Policy Committee are known to share this view, or at least think more research is needed.

"There is no doubt that productivity is growing faster than is being measured, particularly in the services sector," said Darren Winder, economist at Warburg Dillon Read.

The ONS said on Wednesday productivity growth in manufacturing hit a five-year high of 5.6 percent in November, but for the whole economy, including services, it recorded growth of just 1.2 percent.

Winder admitted that bonuses this spring from City financial firms would likely have a further upward effect on London house prices in the near future but that this presented little danger to inflation overall.

"There is also not such an imbalance between the supply and demand for labour as some people would have us believe. Wage pressures have actually eased over the last year," he said.

Dharshini David, economist at HSBC, said while she was worried about earnings growth, which she felt was too tight for comfort, there was as yet little evidence of a renewed surge.

She also pointed out, backing up Winder's point about the supply of labour, that all of the 60,000 new jobs in the Labour Force Survey reported on Wednesday were filled by new entrants to the workforce.

"If this continues, it should help to mitigate some of the upward pressure on wages," she said.

Thus it just might be that Britain may not be on the verge of the classic wage-price spiral so typical of the 1970s and 1980s.

Indeed, Bank of England Governor Eddie George said on Tuesday night Britain looked set to enjoy a continued mix of relatively low inflation, relatively high employment and relatively strong growth in the next few years.-Reuters