Deutsche Bank says weak wage and inflationary pressures will keep the RBA on the sidelines next year

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Wage growth will remain weak and therefore inflationary pressures, and that will keep the Reserve Bank of Australia (RBA) on the sidelines when it comes to an increase in official interest rates.

According to Adam Boyton, Chief Economist at Deutsche Bank, that’s what 2018 holds in store for the Australian economy, suggesting that despite strong employment growth this year wage pressures will remain absent, ensuring that household incomes and spending levels remain under pressure.

“Looking into 2018 we continue to expect very weak wages growth, albeit marginally stronger than that seen in 2017,” he says.

“While many may look at the strength in employment growth over the course of 2017 as suggesting that higher wages growth is just around the corner, we take a different view.”

Boyton says the experience in other advanced economies where labour market conditions are far stronger than Australia underlines why he’s not expecting a solid increase in wage growth.

“[The] global experience would suggest that is unlikely until the unemployment rate moves through old estimates of full-employment, around or a little below 5%,” he says.

“We also draw a similar conclusion by looking at New South Wales, where the unemployment rate has averaged less than 5% for a year now, while wages growth remains stuck
around record lows.”

Given he’s not expecting a solid recovery in wages, Boyton says this will not only act to dampen inflationary pressures but also keep household incomes under pressure, a scenario he says will not warrant a preemptive lift in interest rates.

“The significance of weak wages growth when it comes to monetary policy is not just on the implications for inflation, but on the vulnerability of the household sector should the RBA tighten preemptively,” Boyton says.

“It is, after all, the household sector via variable rate mortgages that is a major part of the monetary policy transmission mechanism in Australia.

“This is not to say that rates can’t ever be tightened, just that the backdrop for household incomes and spending as we enter 2018 suggests tightening remains a less than 50% probability on a 12-month horizon.”

As for the risks to his call, Boyton describes them as “balanced”, noting that the positives from a strengthening global economy are offset by the prospect of falling house prices in Sydney, and with it a slowdown in Australia’s other capitals.

“The coincident global upswing should support Australia,” he says.

“On the flip side, the prospect of falling house prices in Sydney and a slower pace of growth elsewhere could see the household saving rate rise, which would in turn see less household consumption and hence GDP growth [of around 3%] than we expect.”

While he’s not expecting much excitement on the interest rate front, Boyton says the story of 2018 may well be fiscal policy given growing chatter about potential income tax cuts.

“What may provide some assistance to the household sector in the latter part of 2018 and into 2019 is the prospect of income tax cuts,” he says.

“That said, with the need to deliver a budget surplus in 2020-21 still a binding constraint on the Government in our view, any tax relief is likely to be very modest and very targeted.”

Boyton says that he would not be surprised to see the Government announce some modest tax cuts in May’s Federal Budget “that could progressively take effect over the coming years”.

However, while that would help household balance sheets in the future, he says they’re unlikely to lead to an increase in rates, at least in the short-to-medium term.

“The impact on the household sector would be unlikely to enable a 2018 rate hike, although it could well be consistent with a move in 2019,” Boyton says.

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