UBS has some bad news for those Australians expecting a hefty pay increase in the next couple of years

Photo by M. Caulfield/WireImage

At 1.9%, annual wage growth in Australia is growing at the slowest pace seen since at least the early 1990s recession.

It’s creating a major headache for policymakers, limiting revenue streams for the government at a time when there’s more than a few whispers that Australia could lose its top-notch AAA credit rating from Standard and Poor’s.

According to new research from UBS’ Australian economics team — comprising Scott Haslem, George Tharenou and Jim Xu — there’s a good reason why this is happening even though unemployment is falling at the same time economic growth is accelerating: an increased number of Australian workers are having their wage increase “mechanically” linked to the inflation rate, something that grew by just 1.3% in the 12 months to September this year.

“We have analysed a new database of enterprise bargaining agreements (EBA’s) of the pay of more than two million employees – which directly covers around one-fifth (& influences around half) of total employment,” it said.

“Crucially, within this group, since 2011 there has been a near-doubling in the share of workers (to around 25%) whose annual wage increases are ‘mechanically’ linked to CPI outcomes and/or the minimum wage change which is also strongly influenced by CPI outcomes.”

According to Australia’s Fair Work Ombudsman, enterprise bargaining is the process of negotiation generally between the employer, employees and their bargaining representatives with the goal of making an enterprise agreement.

It sets out the terms and conditions of employment between an employee or group of employees and one or more employers.

Essentially, with inflation so weak and with an increased proportion of workers now having their wages set off the inflation rate, it’s weighing on wage growth as a consequence.

This, in turn, is impacting household demand, adding to weak domestic inflationary pressures.

UBS says this is creating a “feedback loop that keeps inflation low”, adding that changes in CPI, along with expectations for inflation, will play an increased role in determining wage outcomes rather than factors such as supply and demand, essentially labour market tightness.

“This new phenomenon is already arguably evident in the revealed trends of the data, given that wage rates weakened further in Q216 to a record low of just 1.9% y/y, despite the fall of unemployment to a more than 3-year low of 5.6%, as well as above trend GDP growth,” says UBS.

And the wage weakness is not just limited to select industries, as shown in this chart from UBS. Not one sector covered by the ABS currently has year-on-year wage growth above 2.5%, the centre of the Reserve Bank of Australia’s 2-3% inflation target.

Given the greater influence that inflation is having over wage negotiations, UBS says that this should help keep CPI subdued ahead, keeping the RBA on hold for most of the forecast horizon.

“Absent a potentially greater exposure of wages to exogenous inflation shocks (like rapidly rising oil prices), this dynamic argues any cyclical up-turn in wages this cycle might be slower than in the past,” it says.

“Despite our relatively upbeat growth outlook and the turnaround in commodity prices which boosts nominal growth, headline CPI should stay soft, only returning to the RBA’s 2-3% target in 2018.”

However, while UBS says that that wage and inflationary pressures will remain subdued in the period ahead, it believes the RBA’s rate-cutting cycle is now probably over unless core consumer price inflation — currently running at 1.54% year-on-year — “lurches” even lower in the quarters ahead.

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