Why the RBA isn't rushing to lift interest rates

Picture: Getty Images
  • Like Australia, New Zealand’s jobs market has been running hot over the past year.
  • New Zealand unemployment currently sits at just 4.4%, below the level where wage pressures are expected to accelerate.
  • Australian unemployment remains well above the point where wage growth is expected to accelerate, explaining why wage and inflationary pressures remain weak.

Like Australia, New Zealand’s jobs market has been running hot over the past year.

According to data released by Statistics New Zealand (StatsNZ) today, employment growth surged by 3.1% over the past 12 months in seasonally adjusted terms, including a 0.6% increase in the March quarter.

Despite an increase in labour force participation over the year, lifting 0.2 percentage points to 70.8%, the surge in employment saw unemployment tumble to just 4.4%, the lowest level in nearly a decade.

It now sits well below the 4.7% rate the Reserve Bank of New Zealand (RBNZ) deems to be the labour market’s non-accelerating inflation rate of unemployment (NAIRU), the level where wage pressures are likely to accelerate.

However, there’s a problem.

Like so many other developed economies in recent years such as the US, UK and Japan, wage pressures in New Zealand remain close to non-existent.

According to StatsNZ, its labour cost index (LCI) rose by 0.3% in the March quarter, leaving the increase on a year unchanged from the December quarter at 1.8%.

Without a large legislated pay increase for care and support workers last year, StatsNZ said LCI would have increased by just 1.6% over the year.

As seen in the chart below from StatsNZ, despite unemployment remaining below NAIRU for several quarters, both wage and inflationary pressures in New Zealand remain incredibly weak.

Source: StatsNZ

And that brings us to Australia, where similar trends have been evident in recent years.

Even with strong employment growth over the past year, Australia’s unemployment rate still sits at 5.5%, well above the 5% level the Reserve Bank of Australia (RBA) estimates as Australia’s NAIRU level.

Like New Zealand, strong population growth — primarily through increased migration — has helped to boost the size of Australia’s labour force, keeping unemployment higher than what would otherwise have been the case given strength in employment growth.

And with unemployment currently sitting well above its estimated NAIRU level, that’s undoubtedly contributed to some of the weak wage and inflation outcomes seen in over the past few years.

As the RBA has documented on countless occasions in recent months, it expects that unemployment will gradually move lower as economic growth strengthens, helping to boost wage and inflationary pressures in the coming years.

That, in theory, makes sense.

However, if the example from New Zealand and other advanced economies is anything to go by, it’s questionable as to just how fast any increase in wage growth will be in the period ahead.

Not only is unemployment still some 0.5 percentage points above the level where wage growth is expected to accelerate, no one can say with any certainty, including the RBA, as to whether it will accelerate if unemployment moves back towards, or below, 5%.

NAIRU is only an estimate, not a given. You only know when it’s been hit after wage data confirms labour costs are accelerating.

Things like the Phillips Curve, which looks at the relationship between unemployment levels and wage growth, are useful in helping to estimate where it’s likely to sit, but even it has weakened in the years following the global financial crisis.

Given recent trends both in Australia and abroad, it’s now increasingly uncertain as to when wage and inflationary pressures will build.

With unemployment still well above Australia’s estimated NAIRU level, and given the heightened level of uncertainty, that explains why the RBA is currently in no rush to lift official interest rates.

It also means that upcoming labour market data, especially Australia’s Wage Price Index, has taken on increased significance when it comes to the outlook for monetary policy settings.

The latest version of that report, capturing wage movements in the March quarter, will be released on May 16.

On the current evidence, it’s unlikely to deliver welcome news for workers.

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