The persistently high interest rate environment means companies are under pressure to cut costs and jobs are an obvious target. While they can cut their workforce through redundancies or slash the wage bill through shorter or fewer shifts, others might already be operating with a skeleton crew and cannot pare back any further.

It is against this scenario that higher wages are adding to companies’ problems and threatening to dilute their profit margins – something the market does not like, thus acting as an anchor on share prices.

The latest UK wage growth figures came in hotter than expected, up 5.6% in the three months to February. Furthermore, UK companies have this month found themselves nursing another headache in the form of changes to the National Living Wage. The minimum amount paid to workers has gone up by approximately one pound per hour to £11.44 and the minimum qualifying age has moved from 23 to 21. More money for more people.

TWO OPTIONS FOR COMPANIES

The hospitality and retail sectors are particularly exposed to the National Living Wage changes and there are two ways that companies can respond – swallow the extra costs and suffer a hit to profit margins or pass on the extra costs to the customer.

The latter is a risky strategy in a period where everyone expects inflation to fall and the public has already had enough of big price hikes over the past few years. However, the recipient of the pay rise will have more money in their pocket, so companies need to decide if hiking prices is a risk worth taking.

There are other factors to consider. The additional two percentage point cut to national insurance announced in March and actioned from 6 April is worth £450 annually to the average worker, according to the Treasury. Another boost to their finances.

In the supermarket’s latest results, Tesco (TSCO) chief executive Ken Murphy said price inflation in groceries had ‘lessened substantially’, suggesting that the rapid rise in the cost of a weekly shop is already slowing. Energy bills are also declining – from 1 April, the typically energy bill fell to £1,690, the lowest price in two years.

GENEROUS PAY RISES

Supermarkets will be happy as many firms have pushed through bigger pay rises than required until the National Living Wage so they could do with customers filling their baskets to help cover the extra wage bill. For example, Tesco is lifting its hourly pay by one pound to £12.02 per hour from 28 April, representing a 9.1% pay rise.

These factors combined suggest that consumers should be in a better situation to get their finances under control. That clarity could feed into greater confidence which in turn could lead to higher spending – thus companies facing higher wage bills might not be facing disaster.

However, demand for certain goods and services is still fragile and companies cannot sit back and assume consumers are going to splash the extra cash in their pocket. Therefore, aggressive price hikes to cover extra wage bills could easily backfire.

‘In 2024, businesses will hope for a quicker-than-expected fall in inflation and interest rates, but many moving parts need to slot into place before we can be sure of an economic “soft landing”,’ says Jo Robinson, a partner at consultant EY-Parthenon.

‘We expect to see increasing disparity between businesses that are positioned to capitalise on still-limited growth and those that are hampered by the impact of recent earnings pressures or their access to and the cost of capital. It is shaping up to be an easier year for many, but not all UK companies.’

WHAT ABOUT OVERSEAS COMPANIES?

At face value, it seems as if many UK companies might weather the storm with the extra wage bill. How does that compare with other geographic territories? It looks as if the UK might have a small advantage but the situation is far from perfect.

Big companies with operations around the world continue to lay off staff, including many in the tech and banking sectors. An uncertain economic outlook means management teams need to take a prudent view of near-term earnings prospects. For example, Tesla (TSLA:NASDAQ) is cutting 10% of its workforce as it has become harder to sell electric vehicles despite price cuts.

International recruitment consultant PageGroup (PAGE) on 15 April reported a drop in quarterly profit for every single operating region, including the UK. Companies lack confidence in the near-term outlook and we are seeing a slowdown in hiring activity. Even people in receipt of a job offer are taking ages to accept them, says PageGroup, a sign of nervousness to move job. No-one wants to accept a new role and then find out why the ‘last in, first out’ mantra has stood the test of time.

A year ago, people predicted interest cuts would have happened by now – they have not, apart from a small group of countries. Businesses and consumers are both under pressure and that has a profound impact on spending decisions.

Companies that continue to pass on extra costs to customers are simply adding to these pressures and this can fuel inflation, which in turn gives central banks even less of a reason to cut rates. That poses a risk to equity and bond markets which have been desperately waiting for the central bank pivot in monetary policy. With the economic winds continuing to blow in different directions, investors will need to stay focused and patient.

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