State pensions for April 2022 are set to be more expensive than previously expected after average earnings figures for the UK rose 5.6% and consumer price index (CPI) data jumped to 2.1% – up from 0.7% in April.
The UK state pension is protected by the triple lock – meaning that yearly increases are based on the highest of average earnings growth, CPI, or 2.5%. It is also legally required of the chancellor that the rise has to be at least in line with earnings growth.
With the current data, the Treasury is set for a “multi-billion-pound bill” to pay for the pension hike next year, according to analysis by LCP partner Steve Webb.
This is because, even though inflation is increasing quickly, earnings are growing at a much faster rate, meaning that in the Autumn when the UK government has to decide on pension increases, earnings are likely to be the biggest figure of the three.
‘Artificially high’
Webb said that there two reasons for the “artificially high” earnings figures released by the Office for National Statistics (ONS):
- One is due to the ‘base’ effect, where wages were lower due to the start of furlough last year and the current growth is not caused by workers earning more but because wages have been restored to pre-pandemic levels;
- The second is based on ‘composition effects’, where job losses in the past 12 months have been heavily concentrated on lower-paid sectors and the removal of such types of employment drives up the average pay in the country.
As a result, the ONS estimated that, without these two effects, figures would have been around 3%.
Options
Webb believes the chancellor has two options if he wants to stick to his manifesto commitment and keep the triple lock in place.
The first one would require him to discard the ‘distortion’ in the data and use the ONS’ estimated 3% that would have effectively been; or apply the triple lock formula over a two-year period, meaning that this year’s earnings growth would be partly offset by 2020’s fall.
Webb said: “Even without the triple lock policy, the chancellor has a problem because the law requires him to link pensions to earnings growth as a minimum. Current earnings figures are soaring away and a simple link to earnings growth will result in a multi-billion-pound bill.
“There can be little doubt that the chancellor will be looking for ways to ‘fudge’ the earnings figures [and that] Treasury officials will be very busy over the coming months looking for creative new ways to measure the growth in wages.”
Sarah Coles, personal finance analyst at Hargreaves Lansdown, added: “If the government sticks with its formula for the triple lock, this will automatically feed through into state pension rises. A wild wage inflation figure would push pension rises through the roof.
“The government has the option of taking double-digit pension rises on the chin, making temporary changes to the formula to ease the pension rise next year, or tweaking the triple lock itself. The triple lock is the bedrock of people’s retirements, so any questions over its future are bound to raise the alarm. However, it’s also politically difficult for the government to touch it, so it will be wary of making major changes.
“One option would be to tweak the formula to account for smoothing of earnings. This allows the government to maintain the triple lock, whilst simultaneously reducing its potency and any unanticipated consequences as a result.”
