Labor costs, especially for the services sector, are usually a large part of the total costs. In the sectors that are more labor intensive, wage increases are more likely to lead directly to higher consumer prices, as companies pass their cost to consumers.
The extent of this relationship will vary significantly IMO by th industries being affected, the overall strength of the economy, and consequently, the pricing power companies can ultimately have. Additionally, it depends on whether productivity gains are offsetting a portion, all, or none of the wage growth.
The effect could also happen through income, higher wages mean more disposable income for households, boosting or sustaining strong demand for goods and services.
We haven’t yet done in-depth research or developed our own historical calculations on the correlation between wages and inflation. I’ve started monitoring this closely, as both the Federal Reserve and the ECB have emphasized wages as a key factor for sustainably bringing inflation back to the 2% target.
These are some research articles I found for the US:
- The Richmond Fed, using a Granger causality test, identified a significant positive correlation between wage growth and services CPI but not goods CPI over the 2000-2022 period. This relationship became particularly pronounced post-pandemic. They didn’t quantify the exact relationship though (IMO this is not fixed, is most likely dynamic as is dependent on a lot of other factors as I described above)
- The Boston Fed also observed a strong positive correlation between core PCE inflation and growth in the Employment Cost Index (ECI) over the past four decades,and particularly in 2021 and 2022, when both increased sharply. However, given the influence of other significant shocks in both metrics, wage growth accounted for less than 15% of inflation at the peak of the recent inflationary episode, a lower contribution than during the 1970s, where wages was the primary driver of inflation, creating a wage-price spiral. (This is contributing to my thinking that the relationship will vary a lot depending on the conditions in the economy)
I don’t necessarily currently view wages as a significant risk for triggering another wave of inflation (though further acceleration above current levels should be monitored). While wage growth is high relative to recent historical trends, it has stabilized, reducing the likelihood imo of a near-term wage-price spiral. Instead, the primary risk for me is that it could be creating some stickiness in CPI growth, particularly within the services sector.
In its recent conference, the Fed noted that wage growth is currently in line with 2% inflation only if productivity gains continue to be strong. However, productivity gains have been easing a bit, raising questions about the durability of the gains in the near term for me.
Powell also said he is still uncertain productivity gains will remain strong, since it is common to see it rise after a shock and then return to the mean.