UK unit labour costs increasing at almost 5 percent a year

Here is another data series warning us that unemployment is about to rise. It also suggests that we are still a long way from deflation.

Unit labour costs, as the name implies, measures the employment cost of producing one unit of output. Two things determine unit labour costs; the productivity of workers, and wages. In the fourth quarter of last year, this series was increasing at 4.7 percent; its fastest rate in eight years.

At a previous post pointed out, UK labour productivity turned negative towards the end of last year. However, the rapid rise in unit labour costs also highlights the fact that wages are outstripping productivity.

The extraordinarily sharp rise in unit labour costs tells us that workers have not yet bought into the deflation story. If they had, they would have expected prices to fall, and they would have moderated their wage claims. Therefore, we wouldn't have seen the sharp Q4 rise in unit labour costs.

Firms facing such a rapid increase in costs are faced with a stark choice. Either they pass these costs on to their customers in the form of higher prices, or they try to reduce costs by firing workers. In practice, firms will try both strategies.

This data neatly complements the unexpectedly high CPI data in February. In the short run at least, firms are trying to push higher labour costs onto customers in the form of higher prices.

Whether they can sustain this cost price inflationary push remains to be seen. What is clear, however, is that the labour market hasn't yet received the memo from the monetary policy committee on deflation.