Household spending power squeezed as wage growth and inflation converge

Rob Morgan, Chief Investment Analyst at Charles Stanley

The UK jobs market continues to cast a shadow over household finances. Unemployment has crept up from 4.4% to 4.7% this year, while the number of employed individuals has steadily declined since last October’s Budget – when the Chancellor announced a hike in employer National Insurance contributions. This reflects growing caution among businesses around hiring and retaining staff, especially in the hospitality industry. Reinforcing the glum picture, job vacancies have been falling consistently.

Wage growth, which had been robust, is now losing momentum. July’s figure of 4.8% represents a significant drop from the 5.9% seen earlier in the year. While still strong on the surface, it masks the effect of persistent inflation eroding household spending power. Rising prices and elevated borrowing costs for mortgage holders are offsetting income gains, leaving little room for optimism in household budgets. And with potential tax increases looming later this year, consumer confidence remains fragile. Overall, a continued ‘safety first’ mindset among households is likely to dampen any prospects for a consumer-led economic rebound.

What does it mean for interest rates?

The Bank of England cut interest rates last month, but a rare three-way split among MPC members revealed divisions in Threadneedle Street over the future path of monetary policy.

For some, stubborn inflation remains the chief worry. With price growth well above the 2% target, there’s a risk that inflation becomes embedded in consumer expectations and business decisions. Others, however, see clear signs of economic weakness – enough to suggest a downturn in demand is approaching, which could ease price pressures.

The strong momentum seen in the first half of the year is expected to fade, and with November’s Budget adding uncertainty, the outlook for growth is increasingly shaky. A rate cut this week is unlikely, and the possibility of another reduction before the year-end hangs in the balance.

Today’s employment data underlines the fragility of the labour market, potentially a warning sign of deeper economic trouble. Yet it’s not weak enough to override inflation concerns and sway the majority of MPC members toward further easing. Some may even interpret falling employment as a temporary reaction to higher costs rather than a true demand slump, especially with wage growth still contributing to services inflation.

In short, while labour market trends support the case for another rate cut, inflation remains the obstacle. With tomorrow’s CPI figure expected to come in at nearly double the target, the optics are challenging for further easing. Sub-4% interest rates may have to wait until 2026.