MNI POLICY: RBA Downgrading View Of Preferred Wage Growth

The Reserve Bank of Australia’s disappointment with productivity growth is prompting it to downgrade its preferred rate of wage increases, making further upward revisions of its inflation projections and a more hawkish approach to rates-setting more likely, external economists and ex-board members told MNI.

The Reserve's recent focus on productivity means it believes inflation will persist more than it had previously anticipated, with pay increases a driver, despite the fact real wages have lost ground during the current surge in inflation, said Timo Henckel, senior lecturer at the ANU College of Business and Economics and current chair of the university’s shadow RBA board. The pivot to productivity could also nudge the government to act on supply-side constraints, Henckel added.

“I think [the RBA] is seriously concerned about inflation becoming entrenched and inflation expectations anchored," he argued. "It’s trying to push on the wage growth brake now, even though for years it talked about the need for real wage increases. The RBA has now gone in reverse.”

While prior to the pandemic, the RBA wanted 4% wage growth, it was likely now targeting 3-4% as more appropriate for its 2-3% inflation target, said Bob Gregory, emeritus professor at the ANU’s Research School of Social Sciences and a former RBA board member.

"Now that nominal wages growth has begun to lift, the RBA has naturally wanted to put more emphasis on nominal wage outcomes and emphasise the close links between nominal wage growth, inflation, productivity increases and real wages," he said. "In general, the lower the productivity increases, the lower nominal wage growth that would be consistent with their inflation target."

The central bank doubts whether productivity can turn around in the medium term, while wages will continue to strengthen, MNI understands. Despite aggressive monetary tightening – the cash rate has increased 400 basis points since May 2022 to 4.1% – the labour market remains tight, with unemployment falling 10bp to 3.6% in May, while the wages price index recorded 3.7% growth over the March quarter – its ninth straight rise.

“If we had higher productivity growth, then wage growth would be less concerning and less an obvious distributional battle between profit and wage sharing,” Henckel said. “With productivity stalling, any wage increases will become more noticeable.”

While recent measures of productivity have shown a rapid decline – GDP per hours worked recorded one of its sharpest y/y falls on record, down 4.6% in the March quarter – the Reserve compares pre-pandemic productivity to the reopening period, or Q4 2022 and Q1 2023, which was flat. While not as bad as recent reads, the growth in unit labour costs at 3.5-4% will weigh on the RBA Board’s July 4 decision, MNI understands. The RBA wants that figure closer to 2-3% to return inflation back to target. The current interest rate has already beat the RBA's most recent forecasts, which had predicted the cash rate to peak around 3.75% in May 's Statement on Monetary Policy. The Reserve will update its expectations in August.

But Henckel warned against placing too much emphasis on productivity estimates, as they could change rapidly and be subject to supply or demand forces, which are often hard to differentiate.

Gregory noted changes in productivity outcomes in the short term were not as significant as large shifts in nominal wage increases. "The productivity discussion is about possible outcomes of 0.5-1% increases a year, at the most," he continued. "The nominal wage discussion is about stopping wage increases from lifting to above say 3.5% to the levels that would be required to offset the real-wage falls of the recent past and those generated by further periods of 6% inflation."

He added the productivity-wage-price discussion was likely driven by the low probability of real wage increases in the near future and to prepare the public for the more realistic chance that real wages will fall further.