Turbulent times for pay forecasting and the National Living Wage

September is often a month in which financial projections for the following year are reviewed by organisations and pay forecasts play an important role in that financial planning. Payroll is for many organisations their largest single line of expenditure.

Pay forecasting is never easy. It isn’t normally linked to isolated simple factors. Most people look at what is happening in terms of inflation in the economy. Where prices are rising, people generally need pay rises to stand still to afford this year what they could afford last.

Recruiting and retaining employees is also a market in itself, and most organisations look to each other to see what pay increases are generally being made, for example by looking at average earnings within the economy and reviewing pay awards. Pay award data is usually looked at from a sector-by-sector perspective.

Finally, organisations will normally look at the above information alongside what they can afford. Whatever is happening in the economy, affordability will have an impact on what an employer can realistically budget for and pay.

That is not to say there will not be other factors which will be taken into account. Recruitment pressures are a good example. National living wage is another. However, these factors more commonly lead to some tailoring of pay awards, where perhaps different levels of increase are applied only to a targeted area.

Inflation

Inflation is turning out to be volatile. Pay determinations tend to have been made using CPI (Consumer Prices Index) rather than RPI (Retail Price Index) in more recent years. This is due to the fact that RPI has been discredited and dropped by the ONS as an official national statistic (although it is still calculated and published).

RPI uses the Carli formula. Putting it simply, the problem with that formula is that it takes into account price rises in goods but does not then factor circumstances where prices return to normal. On average it is believed that the RPI measure has overestimated price inflation by 0.7% annually.

CPI tends to be lower, but CPI has consistently been rising since the economy began to open up in March 2021. It has travelled over that period from below 1% to now standing at 3.2% (August 2021). Forecasts for next year seem to indicate a predicted range of 3% to 4% for 2022. August’s figures are the largest jump on record; from 2% to 3.2% in one month.

Market data

Pay rises have remained stubbornly low lately, with market data hovering around 2%.  Contrast this with average earnings; 8.3% higher in July 2021 compared with a year earlier.

To a degree, we need to take average earnings with a pinch of salt. It is acknowledged that the present figures are being influenced by the pandemic in two ways. Firstly, through the “base effect”, which means that we are comparing pay at this time with a period last year where people were more likely to be on furlough or working less hours than they would normally.

Secondly, through the “compositional effect”. This is the tendency for lower paid workers to be the ones suffering unemployment through the pandemic. Those remaining in employment tended to be higher paid, so the average earnings calculation again becomes inflated.

Affordability

The pandemic impact will clearly be affecting affordability for businesses.  Furlough support from the Government ends at the end of September 2021, albeit that the support is only 60% at this stage in the scheme. Businesses will presently be digesting the impact of the announcement that in the tax year beginning in April 2022, national insurance contributions will increase by 1.25%. Added to this, many employers will be factoring in the increase in National Living Wage in April 2022.

National Living Wage

We’ve seen little revision to projections for the National Living Wage (NLW).

The last published data is that from the Low Pay Commission’s Uprating Report in April 2021.

So, from the present living wage of £8.91, the projection for 2022 is an increase to £9.42.  That is an increase of 5.7%.

We need to bear in mind that 2021’s increase to £8.91 was heavily influenced by the pandemic. The calculation is heavily influenced by average earnings in the economy and when the rate was fixed in October last year, the impact of the pandemic meant that it was very difficult to read the average earnings data. The LPC put it like this:

“We have had to recommend rates that best balance the desire to increase pay with the need to protect employment, in the context of the Covid-19 economic shock. Employers are in a weaker position to respond to National Living Wage increases without reducing employment, particularly in the low-paying sectors that have been most affected and have been most likely to furlough staff.”

So, the approach was not the usual average weekly earnings plus X% approach.  It was in fact below where they needed to take NLW to meet the target of 2/3 average earnings by 2024.  There’s another important line to note in the Uprating Report:

“Our approach this year was therefore to recommend rates that minimise any ‘significant risk’ to employment prospects, as per our remit. This led us to recommend a 2021 NLW rate of £8.91. This is lower than our best estimate of the on-course rate of £9.06, but importantly it is modestly higher than the increase in prices.”

This means that there is a need to catch up at some point. It’s possible that absolutely no headway was made towards bridging the gap to 2/3 average earnings in 2021. This increases the possibility of the increase next year, or thereafter, being higher.

We might well see a figure higher than £9.42 announced when the Autumn Budget is set out on 27 October 2021, which is when the figure is expected to be released. This makes it difficult to predict the figure now.

Our recommendation

Co-operatives UK is recommending that employers factor into projections for next year that NLW may rise by up to 7% and be somewhere around the £9.50 mark.

The single most difficult factor to predict is how the Low Pay Commission will factor in affordability for 2022. Redundancy fears linked to the scaling down of furlough have not materialised. There may be some impact seen when the scheme closes completely.

At present redundancy rates are falling month on month. Employment rates are high and are holding up, unemployment is low and has been falling.

It would be a risky strategy to plan your finances for next year in the hope that the LPC holds back the NLW again to aid recovery in the economy. Be prepared for large increases in the NLW next year because it could well happen.