Components of Inflation: Wage Inflation

Learn the Importance of Wage Inflation

Increasing Wages
Wage Inflation Precedes Rate Hikes.

Components of Inflation: Wage Inflation

Inflation is a key component of central make planning. Inflation is the tendency for prices to increase for common goods and services, which often aligns with a fall in the purchasing power of money. One of the key ways that inflation takes place is there an increase in money supply, which is governed by the central banks. An increase in money supply and demand for labor often leads to wage inflation also known as wage pressure, which is a term for a rise in income.

We’ll discuss how wage inflation is tracked, what it means to currency traders, and how central banks look at wage inflation.

How Wage Inflation is Tracked

Wage inflation comes out via employment reports. The Federal Reserve has mentioned they look at wage inflation as a key component to both employment and inflation making it key to their determining whether or not interest rates should rise. The common measures of wage inflation are average hourly warranty earnings or AHE, average hourly earnings for non-supervisory workers, employment cost Index or ECI, median usual weekly earnings, and unit labor costs.

Basically, they’re trying to get a wide reading of whether or not there is wage pressure in the economy or not. As you can imagine, based on the massive amounts of quantitative easing the central bank has embarked on they expect the money supply to lift up the economy. This is the basics of the trickle-down theory.

Trickle-down theory is the economic idea stating that financial benefits given to big businesses will, in turn, pass down to smaller businesses, employees, and consumers. This is effectively the same method that central banks use across the board.

Where did all that money go?

With so much money added to the system since 2008, roughly $4 trillion according to the Federal Reserve, it was expected that companies would use that money to pay more for the talent on their books or that they’re looking to acquire.

So far, a majority of that money has not been used specifically for increasing wages which is caused wage inflation to lag the Federal Reserve’s expectations.

Instead, the Fed's ultra-easy monetary policy such as seven years of a zero interest rate policy or ZIRP and the quantitative easing has simply given executives incentives to issue cheap debt and buy back company stock. As of late 2014, S& P 500 buybacks have told roughly $2 trillion from 2009 to late 2014. This benefits the executives that own alliance share anyway and has diverted cash the Federal Reserve intended for Main Street to create jobs and invest in new projects that would create more employees being paid better.

What wage pressure means to currency traders

Currency traders are and should be focused on what the Fed is focused on for the next monetary policy move. Because central banks are focused on the employment health of an economy as well as inflation, which is a sign of demand, wage inflation is a crossroads of the two key components for central banks. When wage inflation begins to show its head, it is likely that a rate hike is around the corner. On the other hand, a sharp drop in wage inflation is likely going to bring about easy monetary policy, which will weaken a currency and present a good selling opportunity.

How central banks look at wage inflation.

When central banks see that wages are increasing, investors begin to expect the central bank will lift rates earlier than expected. Recently, the United Kingdom’s average weekly earnings report cause the market to begin pricing in a summer rate hike by the Bank of England versus a late 2016 hike before the announcement. This caused the British pound to rise aggressively versus the US dollar, Euro, and Japanese Yen as well as other currencies.

Recently, Janet Yellen, the chairwoman of the Federal Reserve indicated that while employment has risen the lack of wage inflation has created slack in the economy. This means employment has taken a backseat to wage pressure and therefore central banks are looking to wage inflation to be the last component before rate hike takes place.

Therefore, wage inflation should be in focus for currency traders.