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Inflation and annual pay are not in a one-to-one relationship. That became clear to many workers last year when their annual merit increases in salary and wages were not anywhere near the four-decade highs for inflation. 

Most companies never have, and never will, set pay to match inflation exactly. Once you pay people more, it’s hard to claw that back even when inflation starts to come back down. Employers did pay workers a lot more last year, with the average raise running near two percentage points higher, at 4.8%, than the standard 3% merit increase most often awarded in recent decades, according to data from compensation consultancy Pearl Meyer earlier this year.

The latest data from Pearl Meyer looking at companies across all sectors of the economy also indicates that 2023 won’t be the back-to-three-percent year, though there is evidence of downward pressure in the absolute amount of pay increase.

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

The Pearl Meyer survey was conducted in August and September before the layoffs started to mount at the tech sector’s largest companies, and companies can still adjust their plans in the months ahead based on economic conditions, which has workers worried. But Reilly said that to date, the numbers are “solidly 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 pay increases as high as 5%, he said. Private companies, on average, expect to pay more than publicly traded ones, but the 4% figure represents the median increase across the Pearl Meyer survey of a representative sample of employers throughout the economy.

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

This year, that could be less likely. However, when Pearl Meyer asked the compensation decision makers in its survey to rank challenges they face in 2023, wage inflation and a tight labor market were still at the top of the list alongside 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 employment opportunities and preferences,” Reilly said. “Slightly down, but still above the historical norm,” he said of the overall salary survey conclusions.

“Many companies are still actively recruiting and know the employee mindset has changed, particularly for younger folks,” Reilly said.

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

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

The actual pay increase levels may still change, just like this year, when the raises end up being higher than companies initially forecast. Next year could be the reverse of that, starting with a strong labor market and employee retention front and center as a consideration, but it’s possible the macroeconomic challenges will keep growing, leading companies to lower their salary budgets. Some industries will struggle more than others or be overly cautious due to the economic outlook and roll back their merit increase forecast, Reilly said. But he added, “more are likely to be as generous as they can on a broad-based level.”

One CNBC CFO Council member recently told us that big risk in the Federal Reserve’s interest rate increases is that the labor market is a lagging indicator, looking strong for much of the initial period of rate hikes, but then the layoffs mount throughout the economy too quickly for the central bank to adjust its policy. In spite of this C-suite fear, the data indicates that even amid all the talk of recession and layoffs, 99% of Pearl Meyer survey respondents said they are planning merit increases for 2023 for broad-based employee pools. “The point is that most were not signaling salary freezes, and 4% was a solid number, and seems to align with other external data, and we’re pretty confident on that 4% as the market number,” Reilly said.

Pearl Meyer research indicates that merit increases are a lagging indicator relative to inflation and costs. As inflation moderates over time, as the Fed’s actions work their way through the economy, wherever it settles that should translate to a tempering of the merit increases. “But I couldn’t tell you whether it’s 2024 or 2025, another year or two above average,” Reilly said.

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