Inflation is coming down. Here’s what that means for annual pay raises

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Inflation and annual pay are not in a one-to-one relationship. This became clear to many workers last year when their annual merit increases in salary and wages were nowhere near the four-decade highs for inflation. Many employees resented even as pay was increased by more than had been normal for decades, wondering why their pay wasn’t tied to the Consumer Price Index, which hit more than 9% earlier this year. Workers had a point: real wages were not keeping pace with the prices consumers were paying for everything from groceries to gas and housing.

But most companies have never, and never will, pay to match inflation exactly. Once you pay people more, it’s hard to get it back, even when inflation starts to fall again. Employers paid workers much more last year, with the average raise being nearly two percentage points higher, at 4.8%, than the standard 3% merit raise mostly awarded in recent decades, according to data from compensation consultant Pearl Meyer earlier this year.

As inflation fell and there was more conviction that the peak in higher prices for the U.S. economy was in, C-suites at least began to ask the question: When will it be right for standard cost-of-living adjustment-linked pay increases to return again? go? We’ve heard this from members of the CNBC CFO Council, but their response to the question so far has been that the labor market is still too tight, and it’s not going to be 2023 for bosses to get back to “normal” in the environment. increase.

Downward pressure on raises, but still tight labor market

The latest data from Pearl Meyer, which looks at companies across all sectors of the economy, also indicates that 2023 will not be the year of going back to three per cent, although there is evidence of downward pressure in the absolute amount of pay rise.

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“There’s still this sense across industries that wage inflation is strong, there’s still strong demand for talent,” says Bill Reilly, managing director at Pearl Meyer.

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The Pearl Meyer survey was conducted in August and September before layoffs began to ramp up at the tech sector’s biggest companies, including Meta, Amazon, Microsoft and HP, and companies may still adjust their plans in the coming months based on economic conditions, which worries workers, including at Alphabet’s Google. But Reilly said the numbers so far are “solid at 4%” for both executive and rank-and-file pay increases. Some companies in sectors where demand is still high and labor supply is still tight, life sciences as an example, are looking at annual salary increases as high as 5%, he said. On average, private companies expect to pay more than publicly traded ones, but the 4% figure represents the median increase over the Pearl Meyer survey of a representative sample of employers throughout the economy.

Peak payment?

The data does indicate that the peak may be in the level of salary increases at many companies. In 2022, the compensation firm found that total raises were more than 4% for two-thirds of survey participants compared to this year’s median, or 50th percentile, at 4%. And the salary increase was more than 6% for a quarter of organizations. 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 more than 9% in June. One fifth of companies made salary adjustments “off-cycle” this year.

This year, that may be less likely. However, when Pearl Meyer asked compensation decision makers in its survey to rank challenges they face in 2023, wage inflation and a tight labor market still topped the list along with concerns about a more challenging economic climate overall. “For many companies, it’s still really a seller’s market as it relates to employees and job opportunities and preferences,” Reilly said. “Down slightly, but still above the historical norm,” he said of the overall salary survey findings.

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“Many companies are still actively recruiting and know that the mindset of employees has changed, especially for younger people,” Reilly said.

This applies to more than just wages, and right now work-from-home flexibility is one example.

Seventy-five percent of the companies in the survey have some form of hybrid work and one expense not planned for next year, according to Pearl Meyer: any money on office perks and lures to bring more workers back to company locations .

The Fed, inflation and a slowing economy

The actual salary increase levels can still change, as they did this year, when the increases end up being higher than companies initially predicted. Next year could be the reverse, starting with a strong labor market and employee retention as a consideration, but the macroeconomic challenges growing and leading companies to lower their salary budgets. Some industries will struggle more than others or be overly cautious because of the economic outlook and roll back their merit increase forecast, Reilly said. But he added, “more will probably be as generous as they can on a broad level.”

One CNBC CFO board member recently told us that major risk in the Federal Reserve’s rate hikes is that the labor market is a lagging indicator, looking strong for much of the initial period of rate hikes, but then the layoffs take off. rapidly throughout the economy. for the central bank to adjust its policy. Despite these C-suite fears, the data suggests that even amid all the talk of recession and layoffs, 99% of Pearl Meyer poll respondents said they plan merit raises for 2023 for broad-based employee pools. “The point is that most didn’t indicate pay freezes, and 4% was a solid number, and seems to be consistent with other external data, and we’re pretty confident in that 4% as the market number,” Reilly said .

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How long will the higher increases last? Could the standard 3% annual increase be a permanent thing of the past? The Fed’s policy shift is designed to bring inflation back to its 2% target and, on the way there, force higher unemployment as part of that economic tightening. But the Fed is also facing some new pressure from the market to accept that the 2% target is outdated and unhelpful to the economy.

In a CNBC appearance last Thursday, Barry Sternlicht, the head of Starwood Capital, which manages $125 billion for clients, questioned the 2% target as part of ongoing criticism he has leveled against the central bank. “It’s going to be very difficult to get it to 2 [percent] and it’s not necessary,” he said.

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

Pearl Meyer research indicates that merit raises are a lagging indicator relative to inflation and costs. As inflation declines over time, as the Fed’s actions work their way through the economy, wherever they settle, this should lead to a tempering of the merit increases. “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,” one CNBC CFO board member said in a recent interview. And it was a CFO from the technology sector.


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