This week saw another sharp rise in inflation with the Retail Prices Index, up to 5.3%.  The result is that RPI, commonly referred to in pay negotiations, is now at its highest level for over 18 years.

Meanwhile, with the Consumer Price Index at 3.7%, one of the first letters the new Chancellor received was from the Governor of the Bank of England.  This explained why the 2% target had been exceeded for the 5th month in a row.

The Governor’s letter identifies the main culprits as, “…higher oil prices…the restoration of VAT to 17.5% …the continuing effects of the sharp depreciation of sterling...”.  Although the Governor remains positive on an eventual return to target, the Monetary Policy Committee now says “…the pace and extent of the prospective fall…are highly uncertain”.

So where does this leave employers and their pay reviews?  We know from our own UK Reward Management Survey that around two-thirds of companies have pay reviews between January and April.  Most of these are likely to have been planned, and in many cases negotiated, whilst RPI was more than two percentage points below today’s level.  With settlements this year generally in the range of 1 – 2%, pay may well lag real world price increases during most of 2010.

Have we finally broken the reliance on inflation as a key driver of pay?  Is affordability the new reality?  Looking back at the last 24 months you could easily believe so.  But how will the next year turn out?  Will unions continue to accept that real reductions in their members’ disposal incomes are the only way to escape recession?  Or will there be a determined effort to reassert themselves and recover lost ground?