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Analysis: What does low unemployment mean for RBA wages growth forecasts?

• The RBA has been clear that it wants to see inflation ‘sustainably’ at target, with wages growth at 3% plus a key input to that assessment. In this Weekly, we take last week’s better-than-forecast labour market data and find that within the RBA’s workhorse Phillip’s Curve model, the RBA should be able to forecast wages growth at 3% y/y at the start of 2023, almost a year earlier than the November SoMP profile.
• In our analysis we also look at sensitivity to a range of NAIRU assumptions of 3.5-5.0%. The RBA saw NAIRU at around 4-4.5% according to their statements prior to the pandemic. A higher NAIRU sees 3% wage growth by Q4 but a NAIRU at 4 or below would take a few quarters longer. The November SoMP forecasts implied a NAIRU around 4.5%. Where NAIRU is of course remains very uncertain.
• An unemployment rate of 4.2% should also see the RBA revise up their inflation forecasts. Q4 CPI data released tomorrow is also expected to surprise sharply relative to the November SoMP. We pencil in 0.8% q/q against the RBA’s implied forecast of 0.6%, with our forecast annualising at 2.5% y/y, an outcome not forecast by the RBA until December 2023 (NAB Q4 CPI Preview). The RBA will likely now forecast core inflation at the midpoint of the band across the entire forecast horizon.
• Our end conclusion is if the RBA’s sticks to its rhetoric of waiting until wages growth is closer to 3% plus, then the RBA at the upcoming February Board Meeting and SoMP can run a line of early-to-mid 2023 being consistent with rate hikes, though we also think the Bank is likely to continue to pivot away from time-based guidance.
• Nevertheless, these models which don’t see wages at 3% until early 2023 suggest market pricing of 4 hikes in 2022 is overdone. Upside risks to inflation over the next couple of quarters may challenge the patience of the RBA, but it would require a shift in focus away from wages growth for inflation to be judged to be sustainably higher in the near-term.
• Dr Lowe noted back in December that a “a slow drift up in underlying inflation [has] different policy implications to a sharp rise”. Years of below target inflation means there is a still good argument for the RBA to tolerate underlying inflation above the mid-point of the band for a time to ensure wages growth can sustain inflation at target. We also expect further guidance on what constitutes sustainable inflation.
• Our view is that as long as the RBA isn’t forecasting underlying inflation to move above target and accelerate thereafter, the focus will remain on wages, at least in the near term. A faster acceleration in wages growth than implied by this exercise is of course possible, with labour demand indicators very strong and underemployment also at low levels. NAB sees the first rate rise as being in mid-2023 as we think it will take time to have WPI wages at 3%.

Chart 1: Wages growth sensitive to NAIRU uncertainty

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