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Analysis: Outlook for wages with unemployment at 3.5%

• The RBA raised the cash rate target 50bp to 1.85% at its August meeting and continued to communicate that “the Board expects to take further steps in the process of normalising monetary conditions over the months ahead.” It added, however, that “it is not on a pre-set path” a signal that it would be dependent on incoming data flow as to how much more tightening is appropriate.
• That is despite forecasting inflation peaking at 7¾% at the end of this year, and only drifting lower to 4% in 2023 and around 3% in 2024. That kind of inflation profile leaves very little wriggle room for the RBA in getting back to at 2-3% inflation, while also trying to maintain most of the labour market improvement (or in the RBA’s words “…while keeping the economy on an even keel”).
• The outlook for wages growth is central to how quickly inflation will decelerate once global supply shocks abate, and as elevated goods and housing demand normalises. Flowing through the recent fall in the unemployment rate to 3.5% and the RBA’s projections for a mild rise in the unemployment rate to 4% by the end of 2024, implies wages growth of 3¼-4% using the RBA’s models, depending on ‘NAIRU’ assumptions.
• Given Governor Lowe’s prior comments of wages growth of around 3½% being consistent with at target inflation, our findings of a rise in wages growth of between 3¼-4.0% suggests there is a real risk that wages growth accelerates beyond 3½%. That risk is elevated given headline inflation is now expected to peak at 7¾%.
• Even if wages growth stabilises at the 3½% which is thought to be consistent with at target inflation, inflation itself may be higher than desired if productivity growth remains sluggish as it was in the pre-pandemic period.
• Overall, our analysis highlights that the RBA is indeed treading a fine line in trying to chart a credible path to at target inflation, while also trying to maintain the gains seen in the labour market to date. Should wages accelerate more sharply and NAIRU proves to be higher than assumed, the RBA will have little choice but to go more fully into restrictive territory.

Chart 1:  Wages to accelerate, but how far?

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