Inflation is falling. Here’s what that means for annual pay increases

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Inflation and annual wages are not in a one-to-one relationship. That became apparent to many workers last year when their annual earnings increases in pay and wages fell nowhere near the highest inflation rate in four decades. Many workers complained, even as wages were raised more than what had been normal for decades, wondering why their wages were not linked to the consumer price index that rose above 9% earlier this year. Workers had a point: real wages did not match the prices consumers paid for everything from groceries to gas to housing.

But most companies have never, and never will, align compensation exactly with inflation. Once you pay people more, it’s hard to reclaim that, even if inflation starts to come down again. Employers paid their employees much more last year, with the average raise nearly two percentage points higher, at 4.8%, than the standard 3% raise most commonly awarded in recent decades, according to data from compensation consultant Pearl Meyer earlier this year.

Now that inflation has come down and there is more belief that the peak of higher prices for the US economy has arrived, C-suites are at least beginning to ask themselves the question: When will it be OK for standard living wages? raises to go back down? We’ve heard that from members of the CNBC CFO Council, but their answer to the question so far is that the job market is still too tight and it won’t be 2023 when bosses go back to “normal”. raises.

Downward pressure on wage increases, but labor market tightness

The most recent data from Pearl Meyer looking at companies across all sectors of the economy also indicates that 2023 will not be the year of going back to three percent, although there is evidence of downward pressure in the absolute amount of the wage increase.

“There is still a sense across industries that wage inflation is strong, there is still strong demand for talent,” said Bill Reilly, general manager at Pearl Meyer.

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The Pearl Meyer study was conducted in August and September before layoffs began to mount at the technology sector’s largest companies, including Meta, Amazon, Microsoft and HP, and companies may still adjust their plans in the coming months based on the economic circumstances, which employees provide, also at Google from Alphabet. But Reilly said the numbers to date are “solid at 4%” for both executive and grassroots salary increases. Some companies in industries where demand is still strong and labor supply is still tight, life sciences for example, are looking at annual pay increases of up to 5%, he said. Private companies expect to pay more on average than public companies, but the 4% figure represents the average increase in the Pearl Meyer survey of a representative sample of employers across the economy.

Peak pay?

The data does indicate that the peak for the level of wage increases could be upon many companies. In 2022, the compensation company found that overall increases were more than 4% for two-thirds of survey participants, compared to this year’s median, or 50th percentile, of 4%. And at a quarter of the organizations the wage increase was more than 6%. This year, that 75th percentile is at 5%. In 2022, not only was the median closer to 5%, but many companies made mid-year adjustments to pay, with inflation reaching over 9% in June. One-fifth of companies made “off-cycle” salary adjustments this year.

This year that would be less likely. However, when Pearl Meyer asked compensation decision makers in its survey to rank the challenges they will face in 2023, wage inflation and a tight labor market still topped the list, alongside concerns about a more challenging economic environment in general . “It’s still really a seller’s market for a lot of companies when it comes to employees and job opportunities and preferences,” Reilly said. “Slightly lower, but still above the historical norm,” he said of the salary survey’s overall conclusions.

“Many companies are still actively recruiting and know that employee mindsets have changed, especially for younger people,” Reilly said.

This applies to more than just wages, and currently the flexibility of working from home is an example of this.

According to Pearl Meyer, seventy-five percent of the companies in the study have some form of hybrid work and one expense not planned for next year: money for office benefits and enticements to bring more employees back to company locations.

The Fed, inflation and a slowing economy

Actual wage increases could still change, as they did this year, when wage increases end up being higher than companies initially predicted. Next year could be the reverse, starting with a strong labor market and employee retention front and center as a consideration, but macroeconomic challenges are growing and driving companies to cut their payroll budgets. Some industries will struggle more than others or be overly cautious because of the economic outlook and roll back their forecast for earnings growth, Reilly said. But he added, “more are likely to be as generous as they can on a broad level.”

A member of the CNBC’s CFO Board recently told us that the big risk from the Federal Reserve’s rate hikes is that the labor market is a lagging indicator, looking good for much of the initial period of rate hikes, but that redundancies throughout the economy then increase too quickly. for the central bank to adjust its policy. Despite this C-suite fear, the data indicates that even amid all the talk of recession and layoffs, 99% of respondents to the Pearl Meyer survey said they are planning earnings increases for broad employee pools by 2023. “The thing is, most didn’t signal a salary freeze, and 4% was a solid number, and seems consistent with other external data, and we’re very confident that 4% is the market number,” Reilly said.

How long do the higher elevations last? Could the standard annual increase of 3% be a thing of the past? The Fed’s policy change is designed to bring inflation back to the 2% target and enforce higher unemployment on the way there as part of that economic tightening. But the Fed is also facing new pressure from the market to accept that the 2% target is outdated and not helping the economy.

In a CNBC appearance Thursday, Barry Sternlicht, the head of Starwood Capital, which manages $125 billion for clients, questioned the 2% target as part of the ongoing criticism he has leveled at the central bank. “It will be very difficult to get the 2 [percent] and there is no need,” he said.

Even though inflation and wage increases are not in a one-to-one relationship, there is certainly a connection.

Pearl Meyer research indicates that earnings growth is a lagging indicator relative to inflation and costs. As inflation eases over time and the actions of the Fed work their way through the economy, that should translate into a moderation in earnings growth wherever it settles. “But I couldn’t tell you if it’s 2024 or 2025, another year or two above average,” Reilly said.

And as for going back to 3% or 3.5%, “It’s not next year,” a CNBC CFO council member said in a recent interview. And that was a CFO from the tech sector.

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