Here's what needs to happen before Australian wage growth can pick up

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There hasn’t been much to cheer about recently when it comes to wage increases in Australia.

According to figures released by the ABS earlier this year, hourly wages for private-sector workers grew by a paltry 1.8% in the 12 months to December last year, the lowest level on record.

That was merely a continuation of a broader trend with wage increases becoming ever smaller, weighed down by increased labour market slack, low inflation and ongoing weakness in Australian commodity prices.

While on the individual level some have been lucky enough to receive wage increases far larger, for the vast bulk of the population it’s been pretty slim pickings, particularly compared to the wage increases seen in the period before and immediately after the global financial crisis.

It’s got many Australians wondering when, if ever, wages will increase at levels seen in the past.

Well, there is some hope that they can, says Kristina Clifton, an economist at the Commonwealth Bank. It’ll only require a reversal of well entrenched trend and take a long time to do so.

Using modeling conducted by the bank, Clifton suggests that in order for private-sector wage growth to lift back towards levels that we were more accustomed to in the past, it will need to see the nation’s underemployment rate — which largely measures those who are employed but who would like to work more hours — start to drift lower from the record level of 8.7% reported in February.

Here’s how the model has compared to real life wage increases over the past 15 years.

Source: CBA

“A steady decline in the underemployment rate to around 7% in early 2019 would see wages growth returning to its 10 year average of 3%,” says Clifton.

For those who can’t wait that long, or for those who are unbridled Australian economy bulls, Clifton says that in order for wages to grow 3% this year, the underemployment rate will need to tumble to just 5.

Nothing like a bit of optimism, and a bit of luck, right?

While that latter outcome will almost certainly not occur, Clifton says that underemployment will need to start drifting lower in order for the RBA to achieve its medium-term inflation forecasts.

“These projections line up with the RBA’s forecasts, which show inflation only slowly returning to target,” she says. “The Bank’s central forecast is for underlying inflation to remain below the bottom of its 2-3% until 2019.”

For the current quarter, CBA’s modelling suggests that private-sector wages will increase by 0.5%, seeing the year-on-year rate tick up to 1.9% from 1.8%.

However, while further rate cuts would, in theory, help to lift wages by stimulating economic activity and labour market conditions, Clifton, like many others, doesn’t think the RBA will help to speed up this process given growing concerns over burgeoning household debt levels.

“The RBA is unlikely to lower interest rates any further in this cycle. And that is because of financial stability concerns stemming from the rising level of household debt and strongly rising house prices in Sydney and Melbourne,” she says.

“The RBA would prefer to see a slow return of inflation to its target rather than cut rates and see inflation rates increase but household debt rise even further.”

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