Wages growth back to pre-pandemic, RBA’s reaction function not clear
The much-anticipated Q3 wages print is on Wednesday. With core inflation at the lower end of the RBA’s 2-3% target (partly due to pandemic effects), the focus has shifted to when inflation will rise to be ‘sustainably’ at the mid-point of the target. Wages growth at 3% plus has been consistently cited by the RBA as being necessary to sustain inflation at the mid-point of the 2-3% target, assuming 1% labour productivity growth.
In this Weekly we argue wage growth trends have returned to pre-pandemic rates of around 2.25% y/y. We also describe wages setting in Australia and look at recent drivers of wage outcomes, which highlight the slow-moving nature of the WPI measure. Finally, we delve into the RBA’s reaction function, highlighting that while wages growth above 3% is aspirational, ultimately it is about core inflation being at 2.5%.
The once in a generation pandemic saw an unusually large response in wages. Although wages are typically sticky, there were large short-term wage cuts among a small number of employees on individual agreements, while there were widespread wage freezes and wage restraint. That has proved to be short-lived with wage cuts promptly reversed from late 2020. Wages growth is set to be broadly back to pre-pandemic by Q3 2021 with NAB forecasting Wednesday’s WPI to print at 0.6% q/q and 2.2% y/y.
On the public side, there are good reasons to suggest wages growth will return to pre‑pandemic rates. Deferrals of wage increases and lower increases weighed heavily over the past year, but are set to return to pre-pandemic in FY 2022, in some cases with catch up. Award (minimum) wage-reliant employees’ wages are also subject to government policy and are in the process of normalising.
Overall, our assessment is that the wages environment looks to be broadly back to pre‑pandemic. The outlook is also looking positive. In the near term, labour supply dislocations due to interstate and international border closures are anecdotally leading to wage pressures. A resumption of skilled migrants, students and working holiday makers will likely start from late 2021, but importantly this will not happen immediately, with the pace of long-term arrivals a key indicator to watch. In the background a re-assertion of a trend decline in the unemployment rate is expected to drive a more sustained lift in wages pressures. We forecast the unemployment rate to fall to 4.2% by end 2022 and to 3.8% by end 2023.
The RBA’s wish of achieving wages growth at 3% plus is well known, however the reaction function is not as clear. Wages growth is not an explicit target, with the RBA’s assessment of 3% plus wages growth being necessary to sustained inflation at 2-3% based on a 1% labour productivity assumption in a steady state. If near term upside risks to inflation are realised and sustained for a period, wages growth lifts, and the outlook is positive, it will be difficult in real-time to assess where labour productivity is. It averaged only 0.1% prior to the pandemic.
Chart 1: Wages growth in collective agreements has been subdued, weighed by public sector