MNI: Productivity, Wages Keep Pressure On RBA - Ex Officials

Persistent wage growth and sluggish productivity remain a risk to the Reserve Bank of Australia’s hopes of trying to pull inflation back to its 2-3% target band in a timely manner, potentially staying its hand on rate cuts in 2024 despite a slowing economy, former officials and advisors told MNI.

Jonathan Kearns, former head of the RBA’s financial stability department and now chief economist at Challenger, said softer GDP data released earlier in the month had provided the market with a potentially premature rate-cut signal. He questioned whether the economy had slowed enough to allow the RBA to reduce rates in 2024. “What’s the slope of the Philips Curve? How much slowing do we need in the real economy to provide the disinflationary impetus we need? The slowing is necessary, but it may not be sufficient to put rate cuts on the table.”

GDP rose 0.2% in Q3, down from Q2’s 0.4% and below the market’s 0.4% expectation, according to the Australian Bureau of Statistics. (See chart) The market reacted swiftly, lowering terminal rate expectations 4bp across meetings up to late 2024, and a further 40bp for the remainder of the year. The fall also coincided with the U.S. Federal Reserve’s “pivot” signal. (See MNI FED WATCH: On Hold Again As Rate Cut Speculation Builds)

Kearns noted the RBA had done as little on rate hikes as possible, compared to peer central banks, which exposed it to catch-up risk next year. “There are greater risks to the upside through inflation and that places much greater emphasis on inflation and wage numbers, with regard to policy.” The RBA may need to raise the cash rate a further 25bp some time in early 2024 and keep rates elevated, bucking market expectations, he argued.

"If we get slowing economic activity, but inflation and wages don't slow, then we won't have any confidence that inflation will decelerate, needed to usher in a rate cut. I still believe interest rates haven't really been pushed to a very restrictive level," he said. Should wage hikes continue without productivity improvements, then inflation will remain elevated, he added.

PRODUCTIVITY RISK

The Federal Government recently agreed to an 11.8% pay rise for the public service over three years, while Virgin Australia approved a 14-18% increase over the same period. Both were indicative of wage negotiations across the economy that will bake in pay rises over the next few years, Kearns continued. "And if that gets passed through to prices, it's going to be really hard to get inflation down," he added.

Measures of productivity, a key focus for the RBA, strengthened over the quarter with GDP per hours worked rising to 0.9% after Q2’s 1.6% drop and growth in real unit labour costs falling to 1.2% from 2.7% recorded over the prior quarter. However, this improvement was likely driven by a fall in hours worked.

Mark Wooden, professorial fellow at the Melbourne Institute at the University of Melbourne and former Fair Work Commission Annual Wage Review panel member, noted productivity growth had fallen back to 2016 levels over the last few years, regardless of questionable measurement techniques.

However, the RBA would want to see Q3's improvement sustained, he said. “We’re a long way behind where we should be,” he said, adding that real wage growth could not occur without improvements to productivity, which cannot get any worse. Further boosts to productivity next year are likely to come as hours worked continued to fall, Wooden commented.

He questioned whether the RBA should raise rates further, noting the cash rate was likely already too restrictive at 4.35%. “The RBA should be giving more attention to the full employment mandate following the government’s white paper, it shouldn’t just focus on price rises,” he argued. “The language of new [Governor Michele Bullock] doesn’t seem to have changed much from [former Governor Philip Lowe].” But while the RBA had likely hiked too high, it would not reduce it by much with a 3.8% cash rate closer to more normal levels.

The RBA next meets between Feb 5-6.