Treasury inflation warning on public sector pay

The Treasury has warned that high public sector pay settlements could lead to permanently higher prices and interest rates.

It said this could also mean less spending on key public sector services.

The official economic submission to pay review bodies for over 2 million public sector workers comes as unions warn that the Government needs to more than match inflation rates.

The inflation rate is heading above 4 or 5% in the coming months.

Today's document is an attempt to argue the current high rates of inflation are a temporary phenomenon that should not form the basis of public sector pay awards. The setting of wages in the public sector should instead "have regard" to the government and the Bank of England's inflation target of 2%.

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Indeed the document heavily implies that if public sector gives wage rises that exceed or even match 4-5% it will cause inflation to last longer, by encouraging higher wage demands.

The submission says "inflation could become more durable if people come to expect high inflation to continue, for example if workers demand larger wage increases to maintain their purchasing power". It specifically argued that high public sector settlements will encourage similar in the private sector: "If public sector pay increases were to exacerbate temporary inflationary pressure, for instance through spilling over into higher wage demands across the economy or contributing to higher inflation expectations, then these short-term pressures would become more sustained". That would, in turn, harm growth, exacerbate cost of living pressures and require higher interest rates, the document argues.

The submission also argues that higher public sector wage rises will divert funding meant for frontline services such as the NHS and social care, and rejects the argument made by unions that workers should be compensated for the coming squeeze from national insurance rises.

While officially the public sector pay freeze is over, if some public sector workers receive wage rises below the expected rate of inflation, it would effectively be a cut to real incomes.

Inflation is expected to be above 5% in April next year, as a result of rises in energy prices.

Next year Government departments will make submissions to the independent Pay Review Bodies about the affordability of pay rises, as well as an assessment of recruitment and retention, before final recommendations are made to ministers. Some unions are already consulting members over strike action as regards this year's settlements.