- Underlying inflation in Australia remains near the lowest levels on record, remaining below the Reserve Bank of Australia’s (RBA) 2-3% medium-term target for the best part of three years.
- This is unusual given the continued decline in Australia’s unemployment rate in recent years.
- There are many factors that could help to boost inflationary pressures, but none are as important as the need for faster wage growth.
With underlying inflation moving further away from target in the year to September, that stretch of undershooting the RBA’s mandate looks set to extend for some time yet, likely quarters, or potentially years, depending on who you ask.
During a time when unemployment has fallen sharply, sliding from nearly 6.5% in 2014 to just 5% in September, leaving it at the lowest level in six years, the lack of inflationary pressures is unusual.
While that partially reflects recent weak inflationary pressures globally in the post-GFC era, as well as the fact that even with the recent decline in unemployment broader levels of labour market underutilisation still remains at elevated levels, helping to suppress wage pressures, it still doesn’t fully explain why inflation remains so low.
This chart form Morgan Stanley underlines that point.
While it looks like a creation by Mr Squiggle, it tells a story as to just how unusual recent trends have been.
It’s a play on the better-known Phillips Curve which looks at the relationship between unemployment levels and inflationary pressures within an economy.
As indicated by the red line found within the chart, even with the steep fall in unemployment in recent years, underlying inflation still sits just above record-lows, and well below the levels seen when unemployment was at similar levels in the past.
Importantly, with underlying inflation showing little signs as yet of moving back towards the midpoint of the RBA’s 2-3% target, it also means the bank’s cash rate of 1.5% is unlikely to change for the foreseeable future.
Of all the factors that will eventually help to lift inflation back to within target, and allow the RBA to lift official interest rates for the first time since late 2010, none is important than the outlook for the jobs market. In particular, wage growth.
RBA Governor Philip Lowe has previously hypothesised that in order for underlying inflation to hold steady at the midpoint of its target, it would likely require wages to lift by 3.5% per annum, along with some improvement in productivity growth.
The 3.5% level nominated by Lowe remains well away from the 2.1% level where Australia’s Wage Price Index (WPI) grew in the 12 months to June this year.
We’ll get an update on the RBA’s thinking next week with the release of its November monetary policy statement on Melbourne Cup Day, along with its quarterly statement on monetary policy three days later, including updated forecasts on GDP growth, inflation and unemployment.
While the last document, in particular, will garner a lot of attention given the bank will likely lower its unemployment forecasts, suggesting it’s growing increasingly confident that wage and inflationary pressures will slowly build in the years ahead, as has been seen in many other major developed nations in recent years, ultra-low unemployment rates has not translated to wage pressures to anywhere near the same level seen in the past.
The non-accelerating inflation rate of unemployment (NAIRU) — where labour market conditions tighten sufficiently in order to boost wages — is clearly lower than it was the in the past.
With that as a guide, and given we won’t know when NAIRU is hit in Australia until wage growth starts to lift without the assistance of large increases in the minimum rate, that means actual wage data, starting with the September quarter WPI in the middle of this month, could now be the most important data release in Australia when it comes to the outlook for official interest rates.
Until it starts to push meaningfully higher, it’s unlikely inflationary pressures, and the RBA cash rate, will either.
Australia’s September quarter WPI will be released on Wednesday, November 14.