MNI Analysis: Managing Wage Expectations RBA's Toughest Task

By Sophia Rodrigues

     SYDNEY (MNI) - A continuation of the current monetary policy stance for the

time being and patience in evaluating conditions that would require a change are

the two well-known strategies being employed by Reserve Bank of Australia

Governor Philip Lowe. 

     But as questions have accumulated about how quickly wages will pick up, a

third strategy appears to be coming in play -- managing wage expectations.

     Lowe's success in managing this third strategy is very important to how

monetary policy evolves in Australia, as getting inflation to the middle of the

central bank's target band is crucially dependent on the speed and extent of the

wage pickup. The road could be long, as wage growth needs to accelerate to

around 3.5% year-on-year from around 2.0% currently to get inflation into the

middle of the band.

     Managing expectations has always been an important part of a central

banker's job and  inflation-targeting central banks, like the RBA, have

traditionally sought to manage inflation expectations.

     But the current struggle with low inflation has meant that Lowe is having

to add a new dimension to expectations management. He made this admission in the

Q&A following a speech last week. 

     "To the extent that we have a strategy here, my strategy has been to talk

about the benefits of stronger wage growth, to put a floor under wage

expectations," Lowe said.

     It may be the first time a central banker has talked about managing wage

expectations. But as central banks struggle to get inflation close to their

mandated target and as wage growth remains subdued, it's not surprising that the

focus is shifting to managing this key contributor to inflation.

     Since early 2016, the RBA has been flagging subdued labor costs as one of

the reasons for its low inflation outlook. But even after cutting the cash rate

to a record low of 1.5%, wage growth has remained subdued.

     If anything, the RBA's concern about subdued wage growth has increased in

recent months. It has closely followed the situation in other developed

countries, where despite  unemployment rates falling below what was widely

regarded as NAIRU (non-accelerating inflation rate of unemployment), wage growth

has remained low. The risk this could be replicated in Australia as spare

capacity diminishes is unnerving the RBA.

     There are two related risks: wage growth needs to nearly double for the RBA

to become confident that it will achieve its inflation goal on average; and

there is now uncertainty over how much of any acceleration in wage growth will

pass through to general inflation.

     Lowe first talked about the 3.5% wage growth figure in his parliamentary

testimony in August, when he said that to deliver an average inflation rate of

2.5% -- the middle of the target band -- wage growth over the medium term would

need to be 3.5% or a bit higher, with productivity at 1%.

     Lowe even talked about a more optimistic scenario then. "If we do really

well we should be able to expect 4% income growth. On average we are going to

have 2.5% inflation, and let's hope we can deliver 1.5% productivity growth. So,

2.5 plus 1.5 is four."

     Last week, Lowe said much the same thing. While repeating his usual

economic glass half-full argument, his concern may have slipped out when he

discussed how delivering the inflation target would be a challenge if wage

growth didn't accelerate.

     "We are going to have trouble delivering you 2.5% average inflation if wage

growth is 2%. We've got productivity growth occurring at 1% a year, that doesn't

deliver you 2.5% inflation," he said.

     For now, Lowe thinks his strategy of managing wage inflation expectations

is working.  Wage expectations are no longer declining, that's one part of the

strategy, he said. The other is to use current accommodative monetary policy to

run the economy sufficiently fast to generate faster wage growth.

     But stabilizing expectations is one thing, getting stronger wage growth is

another.  It will require a continuation of wage expectations management. And

continued accommodative monetary policy. And lots of patience.

     Lowe acknowledged this.

     "We are prepared to be patient. We are getting there ... making progress.

We will continue to be patient," he said.

     But the road to sufficient wage growth could be long and hard, and managing

wage expectations may not be as simple as it sounds. How long and how hard will

ultimately determine if the cash rate needs to go below 1.5% at some point.

--MNI Sydney Bureau; tel: +61 2-9716-5467; email: sophia.rodrigues@marketnews.com

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