Wage growth will largely determine when the RBA begins to lift interest rates

Jerry Maguire. Source: IMDb, TriStar Pictures, Gracie FilmsShow me the money!
  • The RBA hasn’t increased official interest rates since late 2010.
  • Most economists, traders and analysts, along with the RBA, think the next move in official interest rates will be up, not down — the only question is when.
  • RBA Governor Philip Lowe outlined in a speech overnight that wage growth will play a key role in determining when rates will begin to move higher.

The Reserve Bank of Australia (RBA) hasn’t moved official interest rates for 19 months, the longest stretch of policy stability ever seen before.

And you have to go back to late 2010 to find the last time it raised the cash rate, nearly eight years ago.

While most economists, traders and analysts, along with the RBA, think that the next move in official interest rates will be up, not down, the main question everyone is currently asking is when that will occur.

Although no one knows that answer for sure, including the RBA, Philip Lowe, RBA Governor, gave a clear indication as to what needs to occur before rates will move higher: an acceleration in wage growth.

Here’s a key paragraph from the Governor’s speech delivered in Adelaide overnight. Our emphasis in bold.

Another factor influencing recent inflation outcomes is the subdued growth in wages. Increases in wages of around 2% have become the norm in Australia, rather than the 3–4% mark that was the norm a while back. This is an issue we have been discussing around our board table for some time. While low growth in wages has helped boost employment, it has also put the finances of some households under strain, especially those who borrowed on the basis that their incomes would grow at the old rate. And in terms of the inflation target, it is difficult to see how a continuation of 2% growth in wages is compatible with us achieving the midpoint of the inflation target — 2.5% — on a sustained basis. So from that perspective alone, a pick-up in wages growth over time would be welcome. Perhaps more importantly, sustained low wages growth diminishes the sense of shared prosperity that we have in Australia.

Essentially, Lowe says that for inflation to move back to the middle of the RBA’s 2-3% annual inflation target on a sustainable basis, an increase in wage growth will almost certainly be required.

Earlier this year, he suggested that wage growth of around 3.5% per annum was probably required to keep inflation steady in the middle of the RBA’s 2-3% inflation target, well above the 2.08% level where it currently sits, according to the ABS’ Wage Price Index.

Lowe, based on his speech last night, thinks the process of getting wage growth back to this level will take years, not quarters.

“There has been progress in lowering unemployment and having inflation return to around the middle of the target range, and we expect further progress in these two areas over the next couple of years,” he says.

“The other key point is that the progress we are making is only gradual: our central scenario is for a gradual pick-up in wages growth, a gradual lift in inflation, and a gradual reduction in the unemployment rate.”

So over the next couple of years, he expects only “progress” towards getting underlying inflation back to the middle of its target, not that it will actually be there.

That’s important, signalling that the RBA is in no rush to move interest rates unless upcoming economic data suggests progress in boosting wage growth and inflationary pressures is occurring faster than it currently anticipates.

For financial markets, that means that Australia’s upcoming March quarter Wage Price Index, released on May 16, has once again increased in importance.

As a lead indicator for inflationary pressures, especially for domestic-driven inflation, it will help gauge whether the RBA’s current expectations are on the money.

The full speech from Governor Lowe can be accessed here.

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