Australia's subdued economy to pressures wages, and as a consequence, budget forecasts

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One criticism leveled at the federal Budget was economic forecasts presented by treasury were far too optimistic, allowing the Budget position in the forward estimates to appear far stronger than what underlying economic conditions currently suggest.

One forecast in particular – wages growth – attracted more attention than most. In the budget treasury forecast wages will increase by 2.5% over 2015/16 before accelerating to 2.75% in 2016/17. These figures, far higher than the 2.3% record-low rate seen in the ABS’ wage price index released last week, saw estimates for household consumption and income tax receipts improve as a consequence.

While the treasury forecasts may prove to be correct, there are several domestic labour market indicators at present that suggest wages growth of 2.5%, let alone 2.75%, may be hard to achieve in the years ahead.

CBA, in a research note released earlier today, suggests spare capacity within Australia’s economy – unused or underutilised resources – will keep a lid on wages growth below trend for some time yet.

The researchers at CBA offer three reasons why this is likely to occur.

First, a more flexible labour force enables firms’ greater scope to limit wages growth due to slackness in the labour market. It may be that workers are willing to take lower wages growth for job security.

Second, the underutilisation rate has risen faster than the increase in the unemployment rate meaning that the change in the unemployment rate alone is not fully capturing the lift in spare capacity in the labour market.

Third, job security fears have risen substantially over the past two years. Employees are less likely to look to negotiate a pay rise while job security fears are elevated. Finally, the AUD has not fallen by as much as the decline in the terms-of-trade which means that nominal income growth has been more supressed across the economy than would have otherwise been the case.

Benign wages growth, what the CBA are suggesting, is also likely to keep a lid on inflation and, as a consequence, the outlook for interest rates.

“In our view, the unemployment rate is likely to stay above 6% over the next year which is a fair bit higher than the estimated NAIRU (non-accelerating rate of inflation) of 5.3%. That means that there will be a material amount of spare capacity in the Australian economy which should see wages growth remain modest and inflation well contained. For rates, that means the RBA is almost certain to keep monetary policy highly accommodative. Our base case has the RBA on hold over the next year, but the risks are titled towards further easing”.

While downward revisions to the budget’s fiscal position are nothing new — they’ve been more common than not in recent years — it appears that even before the 2015/16 fiscal year has begun the bar to merely meet expectations is looking increasingly high.

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