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Free AccessREPEAT: MNI ANALYSIS: Strong AUD Burden on Wages Key for RBA
Repeats Story Initially Transmitted at 05:55 GMT Aug 3/01:55 EST Aug 3
--RBA Statement Friday Important for Comments on AUD Impact On Competitiveness
By Sophia Rodrigues
SYDNEY (MNI) - It's widely agreed that the Reserve Bank of Australia won't
shift its current neutral monetary policy stance anytime soon because of the
risks this would pose to household balance sheets but an insight into how the
stance could start to tilt towards easing is likely Friday when the quarterly
Statement on Monetary Policy (SOMP) is published.
The RBA has already said its forecasts for the economy will remain largely
unchanged, and while this is important, the key part of the document will be the
central bank's commentary on the exchange rate.
The RBA already provided a hint on what could be expected by devoting four
lines in Tuesday's cash rate statement to discuss the elevated exchange rate and
the impact it could have on output, employment and inflation if it remained
strong.
The impact would be much greater because the Australian dollar's strength,
as the RBA pointed out, is "partly reflecting a lower U.S. dollar." It is not
entirely due to a rise in commodity prices even though it is clear even an
appreciation related to rise in terms of trade could still have a dampening
effect on growth and inflation.
The August 1 statement was the first time in recent memory that the RBA
discussed the exchange rate in such detail in a cash rate statement. But
detailed commentary in the SOMP is not uncommon.
What is likely to be different this time is the way the RBA characterizes
the risk with respect to wage growth, which has been its top area of concern.
The risk is that an elevated exchange rate could further erode Australia's
competitiveness, thus putting more pressure on labor costs to retain any
competitive edge. But downward pressure on wages is a big risk given the
importance of wage growth to the central bank's forecasts for both inflation and
growth.
During the run-up in the terms of the trade which peaked in 2011, wages
grew strongly and the exchange rate appreciated, resulting in a decline in
international competitiveness of Australia's labor. Since the fall in the terms
of trade began a few years ago, the adjustment in the economy happened via two
key channels - the depreciation of the exchange rate that began in 2013 and the
slowing in wage growth. Unit labor costs in Australia have been little changed
since the terms of trade peaked in 2011.
A RBA bulletin article published in March discussed this in detail. "Since
the terms of trade have been declining, low growth of wages has played the
reverse role of improving international competitiveness, in conjunction with the
depreciation of the exchange rate,"
In a special article in the May SOMP, the RBA further said, "By any
measure, Australia's real exchange rate has depreciated since the end of the
terms of trade boom. This has helped the economy adjust to the significant
reduction in income from the terms of trade decline and the associated fall in
mining investment by boosting activity in the tradable sector."
"An appreciating real exchange rate would complicate that adjustment," the
RBA warned.
To retain competitiveness amid an elevated exchange rate, wages would need
to slow further. But that is a worst-case scenario for the RBA, which is banking
on a recovery in wage growth.
At the Q&A session at the Anika Foundation luncheon last month, RBA
Governor Philip Lowe also stressed the importance of a low exchange rate in
maintaining competitiveness.
The solution to the competitiveness problem - if there is a problem - isn't
lower and lower nominal wage growth. "It largely rests on the exchange rate," he
said.
"The competitiveness pendulum swings with the exchange rate. In principle,
if we thought why we weren't sufficiently competitive, then a lower exchange
rate would be helpful," he added.
A lower exchange rate would help generate more jobs, push inflation closer
to the RBA's target, he said. "So, that's the solution to a competitiveness
problem, not grinding low wages growth at the aggregate level."
Lowe's emphasis on why wages cannot be pushed lower is an indication of how
concerned the RBA would be if the burden for maintaining competitiveness fell on
wages.
In Tuesday's cash rate statement, the RBA said, "One source of uncertainty
for the domestic economy is the outlook for consumption. Retail sales have
picked up recently, but slow growth in real wages and high levels of household
debt are likely to constrain growth in spending."
The RBA's concern over low wage growth was also evident in its commentary
on the labor market, where despite the recent positive development in employment
growth and expectation of a further decline in the jobless rate, the RBA pointed
toward the fact that "wage growth remains low and this is likely to continue for
a while yet."
So if the exchange rate remains high and its dampening impact becomes
evident, the risk is that the RBA may have to ease monetary policy further.
As a 2012 paper published by the Australian Treasury noted, "Should the
exchange rate become too high for macroeconomic purposes, this will be reflected
in rising spare capacity and, ultimately, declining inflation. In these
circumstances we could expect that monetary policy would be eased, putting
downward pressure on the exchange rate."
--MNI Sydney Bureau; tel: +61 2-9716-5467; email: sophia.rodrigues@marketnews.com
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Why MNI
MNI is the leading provider
of intelligence and analysis on the Global Fixed Income, Foreign Exchange and Energy markets. We use an innovative combination of real-time analysis, deep fundamental research and journalism to provide unique and actionable insights for traders and investors. Our "All signal, no noise" approach drives an intelligence service that is succinct and timely, which is highly regarded by our time constrained client base.Our Head Office is in London with offices in Chicago, Washington and Beijing, as well as an on the ground presence in other major financial centres across the world.