With the Reserve Bank of Australia (RBA) unlikely to cut interest rates further in fear of further stoking the red-hot Sydney and Melbourne housing markets, the next move in interest rates will almost certainly be higher, says HSBC’s chief Australian and New Zealand economist Paul Bloxham.
In a note released on Thursday, he says that when official interest rates begin to increase, be it later this year, in 2018 or later, it will require the RBA to be convinced that wage growth is picking up.
“Wages growth needs to rise before the central bank would consider lifting the cash rate, as faster wages growth is needed to lift underlying inflation,” says Bloxham.
However, given heightened levels of uncertainty surrounding current labour market conditions, it’s making the job of determining whether or that’s likely to happen all the more difficult.
“What makes the outlook complicated is that the relationship between wages growth and the labour market appears to have changed,” he says.
“In the past, a closing of the gap between the unemployment rate and the estimate of full employment — currently around 5-5.25% — of the magnitude seen recently, has typically seen a pick-up in wages growth.
“On this occasion, wages growth has continued to fall, despite the tightening of the labour market.”
This chart shows the relationship between the Australia’s unemployment gao and the ASBS’ wage price index.
It’s a conundrum, and something that has not only been seen in Australia but other major economies, with lower levels of unemployment unable to stir inflationary pressures as has been the case in the past.
Bloxham suggests that there’s three possible scenarios that explain this anomaly in Australia: a structural shift in the labour market, previous declines in commodity prices or measurement issues in the official ABS jobs data.
First, it could be structural. One of the clear trends to emerge over the past couple of years has been strong growth in part-time employment and weak growth in full-time jobs. This has meant that, while more people are finding jobs and the unemployment rate remains below the peak seen in late 2014, some of those people want to work longer hours and the underemployment rate remains elevated. In short, the unemployment rate is overstating the degree of tightness in the labour market, which may explain why wage growth has slowed, rather than picked up.
Second, it could be cyclical. In Australia’s case, recent nominal growth in the economy has been mostly driven by the very large cycle in commodity prices in recent years. Although Australia’s exports do not make up a significantly larger proportion of GDP than in other developed economies, Australia’s exports do experience more significant price swings, which drives significant movements in nominal growth. Historically, these swings in commodity prices and the terms of trade have had an impact on wage growth, and may explain part of the recent weakness in wages.
Third, there are considerable measurement issues in the official labour force numbers at present, which makes it more difficult to assess trends, particularly on a timely basis. In particular, the seasonal pattern in employment has changed substantially over the past couple of years, possibly due to survey changes implemented by the Bureau of Statistics in 2014. This has rendered the monthly seasonally-adjusted change in employment largely meaningless.
While few will disagree with his last point, Bloxham explains the conundrum the RBA currently faces when it comes to gauging wage pressures, a major determinant on the outlook for monetary policy.
Out of the three factors that has seen wage growth decelerate to the lowest levels on record, Bloxham thinks that it’s the second — past declines in commodity prices — that probably explains the weakness.
Given that the prices for Australia’s key commodity exports have risen strongly over the last year, Bloxham thinks that bodes well on the outlook for wage growth and inflationary pressures.
And, as the chart below shows, there’s been a reasonable relationship between Australian terms of trade and labour costs over the past three decades.
“We expect the recent lift in commodity prices and national income to support a modest pick-up in wages growth,” he says.
“Although there is considerable uncertainty about the outlook for wages growth, we see the balance of risks as tilted to the upside and expect a modest lift in wages growth in H2 2017, with the RBA lifting its cash rate in 2018.”
It’s likely that the RBA, and Australian workers, hope he’s right.
The ABS will release its March quarter wage price index on Wednesday, May 17.