The multi-decade trend in lower interest rates has been driven and sustained, in large part, by decelerating wage growth. We expect inflation to continue to be moderate, a key pillar of our lower-for-longer interest rate outlook. However, the link between inflation, wage growth and interest rates is strong. Wage growth needs to be closely watched as the labor market continues to tighten.

Average hourly earnings have stalled in recent years 1.5% 2.0% 2.5% 3.0% 3.5% 4.0% 2007 2017 Average hourly earnings WAGE GROWTH HAS STALLED FOR NOW Source: Macrobond, as of January 10, 2018.

We will be watching: Sluggish wage growth is often cited as a key reason that higher inflation has failed to materialize during this expansion. Average hourly earnings growth accelerated in 2015 and early 2016, but has stalled out over the past year. Now, with the unemployment rate at only 4.1%, the labor market is looking increasingly tight. We are closely monitoring average hourly earnings to see if wage pressure will bubble up. Our base case is that wage growth continues to accelerate at a gradual pace, as low-skilled jobs continue to be the source of most job creation, enabling the Fed to stay its slow and cautious rate hike course.

Risks to our view: The combination of a sharp rise in wages and a stronger-than-forecast rise in inflation would signal that interest rates could move higher quickly as the Fed raises rates more aggressively to stem the build-up of inflationary pressure.


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