Why falling inflation and interest rates mean your pay rise could be next

Photo: Getty/Matt Cardy

Australian workers have had little choice but to accept lower pay increases in recent years.

Higher unemployment, increasing the number of available workers, along with disruptive technologies eroding the profitability of more traditional industries, have taken a toll on pay rises, culminating in Australia’s wage price index — a measure on wages and salaries in the labour market — growing by just 2.16% in the 12 months to December 2015, the lowest level on record.

Now there’s another threat that may see that record broken, perhaps as early as tomorrow — the outlook for inflation.

Australia’s March quarter inflation report in late April revealed core inflation grew at the slowest level on record in the 12 months to March – a weakness that came as a surprise to the vast majority of analysts.

Interest rates were cut, the Australian dollar tumbled while 10-year government debt yields fell to the lowest level in more than a century.

While perhaps not as stunned as financial markets, it’s likely that business took note of the sharp deceleration in inflationary pressures, particularly when it comes time to renegotiate the largest expense for many firms, employee wages.

At a time of relatively sluggish growth and elevated unemployment, the weak inflation reading will be seen as a green light by some firms to scale back pay rises.

While it may not apply to individual workers or some industries, collectively, it’s understandable why it’s likely.

Business is not booming, there’s an abundance of available workers and inflation is growing at the lowest level on record, factors that featured heavily in previous negotiations, particularly for private sector workers who saw their wages grow by just 2% on average in 2015.

The chart below speaks volumes.

While Wednesday’s wage price index will capture data before the latest inflation report was released, it coincided with a period when inflationary pressures were already soft and when jobs growth was slowing following a pick up in the second half of 2015, hinting there’s a strong possibility that another record-low increase awaits tomorrow.

For a central bank looking to boost inflation expectations and stimulate household spending, this would be unwelcome news.

There’s nothing like a minimal pay increase to dull enthusiasm for spending. Translate that across the broader Australian labour market and you can see the kind of negativity it could generate.

The RBA is understandably concerned, noting in the minutes of its May monetary policy meeting, released today, that “if inflation was to be persistently lower than previously forecast, it was possible that, in time, this could be reflected in lower wage growth”.

If it became entrenched, it would negatively impact on inflation expectations, household spending, taxation receipts and overall economic growth creating a potentially dangerous feedback loop the RBA understandably wants to avoid.

The chart below, supplied by CBA, reveals the influence wage growth can have on non-tradable inflation, which is influenced by domestic supply and demand factors. As 60% of the Australian Bureau of Statistics inflation basket, continued weakness will do very little to counteract disinflationary pressures.

While it won’t be able to address these concerns in the short term, another weak wage increase will add to the case for the RBA to further reduce interest rates in the months ahead, perhaps even before the August meeting where the vast majority of analysts expect it will next ease policy.

That, broadly, would help to stimulate the Australian economy further, placing additional downward pressure on the Australian dollar which in turn will help to boost both tradable and non-tradable inflation in response.

Bill Evans, chief economist at Westpac, believes the figure will be “closely watched” by markets and policymakers alike, suggesting that a quarterly growth figure of 0.4% will “certainly unnerve the authorities”.

He doesn’t believe such an outcome, in isolation, would be enough to warrant a June rate cut, but it would certainly help to boost expectations of another fall.

John Peters, senior economist at CBA, shares a similar view, although he believes a weak wage and domestic jobs figures over the coming days could see the RBA cut before everyone expects.

“The risk to our rate cut profile is that these policy easings could come earlier,” says Peters. “Any much weaker than expected outcomes in these key numbers could see a pre-August easing.”

While not a noted market mover, it’s easy to see why there’s likely to be so much interest when the report arrives at 11.30am AEST on Wednesday.

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