Reserve Bank of Australia (RBA) governor Philip Lowe has a message for Australian workers.
After years of declining wage growth, it looks like that trend has finally turned the corner and wage growth looks set to accelerate. Slowly.
In a speech delivered at the Reserve Bank’s board dinner in Brisbane overnight, Lowe said that while wage pressures are likely to remain for some time yet, stronger labour market conditions should eventually see a reversal of the recent trend.
“My expectation is that this is going to continue for a while yet, given that the structural factors at work are likely to persist,” he told the audience. “But I am optimistic enough that I don’t see it as a permanent state of affairs. It is likely that, as our economy strengthens and the demand for labour picks up, growth in wages will pick up too.
“The laws of supply and demand still work.
“Even at the moment, we see some evidence through our liaison program that in those pockets where the demand for labour is strong, wages are increasing a bit more quickly than they have for some time.
“The Reserve Bank’s central scenario is that, over time, this will become a more general story.”
While there’s nothing wrong with Lowe’s assessment from a fundamental and historic perspective — wage pressures have increased in the past as labour market conditions have strengthened — it would be understandable if some are a little sceptical as to whether wage growth has turned the corner.
Not only has wage growth in other advanced economies such as the United States, United Kingdom and Japan failed to respond to tighter labour market conditions as what would normally have been the case in the past, optimism from the RBA on the outlook for Australian wage growth is also nothing new.
Just look at the chart below from the RBA overlaying its forecasts for Australia’s Wage Price Index compared to what has happened in reality.
Each and every year from 2011, the bank has forecast a pick-up in wage pressures.
Clearly that hasn’t happened, seeing the bank constantly push back the expected timing of an acceleration in wage pressures.
Nothing has changed in 2017. This year will be different, again.
While few dispute that wage growth will lift in the current quarter thanks to the outsized 3.3% jump in Australia’s minimum wage rate at the start of July, it’s still unclear if this will herald the start of wage recovery, or simply be a temporary disruption to the recent trend.
Even with strong growth in Australian employment in recent months, unemployment still remains at a relatively-elevated 5.6%. Taking into account underemployed workers, labour market underutilisation sits at 14.4%, indicating that there’s still an ample supply of available labour.
As Lowe alluded to in his speech, “the laws of supply and demand still work”, meaning that with so many underutilised workers at present, demand will likely have to improve further in the years ahead in order to bring the market back to equilibrium, allowing wage pressures to build.
‘Some time yet’
The strength of the Australian economy in the period ahead will almost certainly determine whether or not that occurs.
Lowe, mirroring his views on wage growth, was optimistic on that front too.
“The current low level of interest rates is helping the Australian economy,” Lowe said.
“Encouragingly, growth in the number of Australians with jobs has picked up over recent months and the unemployment rate has come down a bit. The investment outlook has also brightened.
“Inflation has troughed and it is likely to increase gradually over the next couple of years. These are positive developments.”
Still, even with clear signs that the Australian economy has strengthened this year, he said that it’s still likely to be some time yet until it’s performing at a level that will warrant higher interest rates.
“It will be some time before we are at what could be considered full employment in Australia and before underlying inflation is at the mid-point of the medium-term target range. This means that stimulatory monetary policy continues to be appropriate,” he said.
“As we make further progress on both unemployment and inflation, we could expect the cash rate to move towards this neutral [3.5%] rate over time.”
So while things are looking promising right now, it’s likely to be some time yet before the economy is strong enough to deliver a self-sustaining recovery in wage and inflationary pressures, allowing the RBA to begin policy normalisation.
And there’s no shortage of uncertainty about what lies ahead, creating risks both to the upside and downside for the RBA’s forecasts in the years ahead.
Australia’s household sector is the chief source of concern right now.
Recent increases in energy prices, at a time when household income growth is already weak, has many concerned that it may crimp household spending in the coming quarters, creating downside risks for the economy.
Bubbles on hold
There’s also concern about the outlook for employment in Australia’s retail and residential construction sectors, the second and third-largest employers in the country.
For retailers, weak household spending, along with new entrants to the Australian marketplace such as Amazon, understandably create uncertainty about the outlook for hiring in the sector.
Only yesterday, the RBA warned in its September monetary policy statement that “low growth in real wages and high levels of household debt are likely to constrain future growth in spending”.
And while building approvals have been fairly solid in recent months, residential construction will still slow in the years ahead, creating downside risks for employment in the broader construction sector despite encouraging signs on infrastructure and commercial investment.
Recent house price and auction clearance rates data has also softened, something that conceivably creates further downside risks to both residential construction and household spending through decreased wealth effect.
Outside of Australia, there’s also uncertainty as to what path Chinese policymakers will take next year — will they continue to support the economy through credit growth, infrastructure investment and residential construction, or will they allow growth to slow to a more sustainable level?
The answer to that question will likely have a large bearing on commodity prices, a factor that has helped to support Australian business confidence and profitability this year, along with revenue streams for the Australian government.
So while things are looking promising for the economy right now, it’s still uncertain as to whether that will last.
The RBA thinks it will but there’s no shortage of analysts who don’t agree.
That means that for anyone looking to celebrate the return of strong pay increases in the years ahead should probably keep the champagne on ice.