If Australia is going to hit its growth targets and lift wages, the equation is simple

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While wages growth remains weak in Australia, there are signs of a tentative pick up in the take home pay of workers.

This is welcome, although it’s too early to be sure if this is a statistical blip or the start of something more promising. Weak wages growth over the last few years has had a significant impact on consumers spending preferences with discretionary spending growth close to zero.

Stubbornly low wages growth has also been a dominant economic and policy issue. Via weak household spending, it has undermined the expected pick up in economic growth, which in turn has kept inflation below the RBA target and official interest rates at a record low.

The RBA cannot and will not increase interest rates while ever these dynamics prevail.

The recent wages data showed that for the first time in almost five years, the end of 2017 saw a pick up in wages growth both in absolute terms and real terms.

The measure of total average weekly earnings, which is the actual dollars and cents workers earn each week, rose by 2.4 per cent through the course of 2017. This was the fastest pace in wage increases since 2014 and with inflation running at just 1.9 per cent, real take home wages increased by 0.5 per cent.

While encouraging, wages growth remains problematic. Average annual wage growth before the global financial crisis was around 4.5 per cent in nominal terms and 1.5 to 2 per cent in real terms. These dynamics pre-GFC saw living standards rise and helped to sustain growth in household spending and contribute to a strong economic performance.

The current income squeeze on Australian workers made worse by record household debt and declining savings, has changed the way householders spend.

Research from RBA Assistant Governor Luci Ellis showed households are scaling back their discretionary spending, whilst growth in consumption of essential goods and services is resilient and has actually picked up in recent years.

These patterns in spending on essentials and discretionary items are no surprise – consumers are both savvy and driven by necessity. Spending on holidays and eating out, for example, is being trimmed, while spending on food, power, healthcare and the like has been maintained.

The recent experience of divergent trends in spending continues a trend evident since 2010 where growth in spending on essentials has been remarkably stable, usually at around 2 to 3 per cent per annum, whilst the annual change in discretionary sending has generally fluctuated between about 0.5 per cent and 6.5 per cent.

The exception to these growth rates was during the financial crisis where spending on essentials dipped to zero. Pessimistic sentiment and rising unemployment took their toll on essential spending, even though the economy did not slip into recession. More stark was the 5 per cent fall in spending on discretionary items.

Which is why stronger wages growth is needed if the economy is to register the sorts of growth rates forecast by the RBA and Treasury. For wages to pick up to a faster and sustained 3 to 4 per cent plus pace, which everyone from the RBA Governor Phillip Lowe to ACTU Secretary Sally McManus wants, the unemployment rate and the level of underemployment needs to fall and fall quite sharply.

Only then, when the slack in the labour market is slowly removed, will pricing power over wages move back in favour of workers.

It probably is that simple.

There are other risks for householders. Leverage in the housing market, with record debt levels, is another issue which might yet upset the move to a material tightening in the labour market and higher wages.

House prices are now falling. Not by much, to be sure, but the change in lending rules and regulations, especially for investors, has seen a reversal in demand and with that a dip in prices.

For now, the house price falls are largely inconsequential and arguably are desirable. But if the price falls intensify, household balance sheets will be damaged, sentiment will be sapped and household spending growth would further weaken which would derail the upbeat assessment of the outlook from the RBA.

Suffice to say, the economy continues to present mixed news for consumers. The wage pick up is welcome, but is still moderate at the same time house price falls are also welcome, but they present a downside risk to household spending.

For now, householders are likely to keep buying essential items but be very cautious about their discretionary spending. Faster growth in wages is needed to kick overall spending higher.

Stephen Koukoulas is Managing Director at Market Economics and a Research Fellow at Per Capita, a leading independent think tank focused on social equality in Australia. You can follow Stephen Koukoulas on Twitter.

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