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A pickup in Australian wage growth could be closer than many think

Picture: Pixar/Disney

Australia’s jobs market is generating a lot of positive signals in 2017, creating optimism is some circles that wage growth will follow next.

However, as workers in the United States, Japan and the United Kingdom can attest, strong labour market conditions do not automatically translate to a lift in wage pressures.

Unemployment levels in those nations all sit at or near multi-decade low, and, as yet, there’s little evidence of wage pressures, with tight labour market conditions not resulting in the wage pressures economics textbooks would suggest.

For Australia, where unemployment and underemployment still sits at elevated levels, it’s little wonder why many think it will be a long time yet until there’s a pickup in wage growth.

It’s also creating a lot of uncertainty for the Reserve Bank of Australia (RBA) who, as governor Philip Lowe discussed earlier this week, are expecting a modest pickup in wage growth to underpin its forecasts for stronger economic growth and inflationary pressures in the years ahead.

Essentially, that means that what happens to wages will probably have a large say in what happens to official interest rates in the period ahead.

While no one knows exactly how things will play out, Gareth Aird, senior economist at the Commonwealth Bank, thinks he knows what will have to happen if wage growth is to pick up.

Australia’s underutilisation rate — which combines unemployed and underemployed persons who currently have a job but want more hours — needs to decline from its current level of 14.5%.

Aird points to the chart below to justify his call.

Source: Commonwealth Bank

It looks at the relationship between annual wage growth as measure by Australia’s wage price index (WPI) and the level of underutilisation within the labour force.

As is shows, in which direction underutilisation goes, annual wage growth tends to go the other.

Currently, underutilisation, or labour market slack, is elevated, helping to explain why wage growth is at record lows.

Given the relationship between the two, Aird says that in order to stir wage pressures, underutilisation will have to reverse its recent trend.

“Our modified Philips curve… suggests that we probably need to see underutilisation fall comfortably below 14% for wages growth to lift,” he says.

The good news for workers and the RBA is that Aird expects that to happen, although, in his opinion, it’s unlikely to be a spectacular recovery that will take wage growth back to the levels Australians came to expect in the period before the global financial crisis.

“In our view, that is unlikely to happen until early next year,” he says, adding that “we are still some way from labour market slack being eroded sufficiently to put genuine upward pressure on wages”.

And, given that outlook, Aird suggests its likely to be some time yet until the RBA will see the need to lift official interest rates.

“Because any improvement in wages growth is coming off a very low rate, we suspect that the RBA will not act to tighten until a solid uptrend is firmly in place,” he says.

“As a result, we don’t see the RBA raising rates until late 2018.”

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