Analysis: The labour market and the outlook for wages
The RBA Minutes today highlighted that the likely timing of the first increase in rates has been brought forward, with June looking more likely with the RBA wanting “important additional evidence… on both inflation and the evolution of labour costs”.
Before June we get another round of forecasts from the RBA in the May SoMP and in today’s Weekly, we look at the likely trajectory for labour costs given the unemployment rate is at its equal lowest since 1974. The unemployment rate is again falling more quickly than the RBA’s February SoMP forecasts.
In summary, with the unemployment rate at 4% and projected to go lower, we see the RBA being able to forecast WPI wages growth at between 3.1-3.6% y/y, assuming a NAIRU of around 4% which is broadly where the RBA thinks NAIRU is.
Importantly the modelling shows a lift in WPI wages to 3% plus could occur almost a year earlier than projected by the RBA in the February SoMP when assuming the faster decline in unemployment forecast by NAB.
Even though wages growth has yet to breach 3%, our modelling suggests the RBA can be increasingly confident in its outlook for wages growth to gradually improve. Such confidence is also being bolstered by wage anecdotes from its liaison program, which was “consistent with a further but gradual increase in aggregate wages growth”.
Seemingly in recognition of greater confidence in the wages outlook, recent RBA communication has lowered the importance of seeing a material lift in wages growth in the actual data before raising rates, though the RBA still wants to see it is on the right trajectory, wanting to see a further evolution in labour costs in the hard data.
There are several limitations to modelling wages using a Phillips Curve, particularly around where NAIRU is. The RBA’s latest ‘best guess’ of the NAIRU is 4%. The central estimate for a NAIRU somewhere in the range from 3.5% to 4.5% sees wages growth of 3.1-3.6% y/y over 2024 using the RBA’s workhorse Phillips Curve model. There are of course other uncertainties around the response of wages, but uncertainty around the level of the NAIRU, while large, does not change the broader trajectory. Note in February the RBA forecast WPI wages growth getting to 3¼% y/y by end June 2024.
As for the labour market itself, the closed border and pandemic impacts on workforce availability continue to complicate the labour market picture, but are unlikely to derail the backdrop of tight labour markets and strong labour demand even as some of the acute pressures in certain pockets ease.
Taken together, the current state of the labour market and the outlook for further improvement should give the RBA confidence that despite the uncertainties in how wages growth will respond at low levels of unemployment, the direction is clear
Chart 1: Wages likely to pick up despite NAIRU uncertainty