Will 2015 be the year of rising real wages?

Several factors suggest that 2015 will be the year when real wage growth finally turns the corner.  What does this mean for property?

10th March 2015

Continue to the other two articles in this edition of the Global Outlook...

Policy Support still crucial for the global economy

The world economy remains on track for a stronger year in 2015 but not without the support of central banks.
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China - short term uncertainty long term opportunities

There is still uncertainty in the Chinese housing market but can this provide opportunities for long-term investors?
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Headline inflation is near a six year low. Should investors be worried about deflation?
Although headline inflation rates across developed markets are likely to turn negative this year, we don’t think investors should be overly alarmed about deflation.

The primary driver of the most recent spell of deflation has been tumbling energy prices, rather than anaemic demand. This is a positive for global growth. As most countries are energy importers, cheaper energy acts as an economic stimulus, in much the same way as a tax cut. 

With oil prices now stabilising, central banks expect deflation to persist until at least the middle of the year.  Reassuringly, core measures of inflation have remained positive since oil prices began to slide last June, indicating that economic activity continues to be robust.  So long as it is temporary, deflation should prop up a budding recovery across the developed world.

While the impact of oil prices gets most headlines, from an economic perspective it is actually what happens to wages that will have the most enduring impact on core inflation rates going forward.
Will 2015 be the year of rising real wages in developed markets?
Since the Great Financial Crisis, real wages across the developed world have stagnated.  Several factors suggest that 2015 will be the year when real wage growth finally turns the corner. 

The most immediate boost to real wages is coming from lower oil prices.  The more inflation falls, the more it boosts the purchasing power of households.

Most importantly, labour markets in developed economies are beginning to heal from the damage caused by the crisis.  Most developed markets are now creating jobs fast enough to bring down their unemployment rates.  In addition, early 2015 figures suggest that labour force participation is no longer on a declining trend.  As the pool of spare labour dries up, companies will need to pay higher wages to attract and retain staff.  Indeed, our analysis of the historic relationship between unemployment and wage growth (the Phillips Curve) suggests some developed markets (particularly the US and the UK) are rapidly approaching unemployment rates consistent with rising real wages. 
What does this mean for property?
Property returns as a whole should benefit from improving macroeconomic fundamentals.  From a demand perspective, a growing economy with jobs growth and rising real wages is a boon for all property sectors.  A return to a strong underlying inflation environment is consistent with rising tenant demand and rental growth.

However, from an asset-pricing perspective, the main longer-term impact will be through a rising cost of capital.  With inflation still below target, central banks have scope of hold off on interest rate rises.  Nevertheless, over the medium-term, an economic recovery and a stronger labour market will put upward pressure on interest rates in developed markets.

There is a risk that investors begin to under-price the prospect of an eventual normalisation in growth and interest rates over the medium-term.  This looks to be a particular concern in some of the larger prime global markets that have benefited the most since the crisis, but which are often the most advanced in terms of the property cycle.

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