In case you’ve missed it, financial markets have recently been terribly excited about the possibility that official interest rates could rise sooner than Reserve Bank governor Philip Lowe has indicated.
The Commonwealth Bank this week predicted rates would increase next year, while Westpac and ANZ Bank think it will happen in 2023. Futures markets have priced in rate hikes in late 2022. Lowe, in contrast, has consistently said it’s “unlikely” they’ll rise until 2024 at the earliest (though he notably left this line out of his latest speech).
RBA governor Philip Lowe’s latest speech excluded his previous comment that interest rates were unlikely to rise until 2024.Credit:Dominic Lorrimer
Whoever ends up being right in the interest rate guessing game, mortgage holders can be pretty confident a rate rise is still a fair way off, and any move would be gradual.
However, beneath the market’s fixation on interest rates there is an interesting story that affects everyone with a job – whether they have a mortgage or not.
That story is about the labour market absolutely booming, sparking predictions the glacial pace of wage growth in Australia might finally start to pick up. Indeed, some economists think the jobs bonanza will result in wage growth getting close to 3 per cent a year by the end of next year, almost double today’s dismal pace of 1.5 per cent a year.
To be fair, that would hardly be a wage explosion, so it’s not yet time for workers to pop the champagne. But if these predictions are correct, it would still be a big change after about a decade of wage growth being stuck in low gear.
So, why are economists getting more upbeat on wages?
Answering this requires delving into a long-running debate over how far unemployment needs to fall in order to generate stronger wage growth, and therefore inflation.
In the past, policymakers assumed that once unemployment fell to about 5 per cent, meaningful wage rises would start to materialise, as employers were forced to pay more to attract suitable staff.
In theory, this stronger growth in pay packets should feed into higher inflation. In economist-speak, this level is known as the “non-accelerating-inflation rate of unemployment” or NAIRU.
Wages in Australia might be on their way up but there’s a lot of catching up to be done.Credit:Matt Davidson
The problem is, in the last decade or so it’s become clear the NAIRU is much lower than 5 per cent. No one knows exactly where the NAIRU is, but many estimate it’s closer to 4 per cent, or possibly lower. Lowe plans to find out. He has signalled the RBA will keep interest rates at ultra-low levels – thus stimulating activity – until it reignites wage growth of about 3 per cent.
Lowe has stressed this will be a slow process, saying it will take “some years” before wages are high enough to get inflation back into the 2 to 3 per cent range. Only then will he raise interest rates.
So what’s changed recently?
Basically, the labour market has been on a red-hot run, creating thousands more jobs than expected, at a time when the supply of available workers is severely constrained because of the international borders being closed.
The consequence has been a rapid fall in unemployment. Last week we learned the unemployment rate was already back down to 5.1 per cent, matching its pre-pandemic level.
APAC economist at Indeed, Callam Pickering, point outs the decline in unemployment for 15 to 24 year-olds has been especially sharp, and it’s now 1.5 percentage points below pre-pandemic levels. This has occurred as hiring in restaurants and retail has bounced back at a time when there are no new foreign students or backpackers arriving to apply for the jobs.
But the decline in unemployment is only part of the story.
There’s also been a big fall in the rate of “underemployment” – people who have work but want more hours. Underemployment was a persistent problem in the decade or so before COVID-19 struck, and was probably one reason why wage growth was so tepid. Now, however, it has fallen to 7.4 per cent, its lowest since 2014.
This is important because economists say the key influence on wages growth is the rate of labour “underutilisation,” which you get by adding the unemployment rate with the underemployment rate.
And on recent trends, the rate of labour “underutilisation” in the economy appears to be falling significantly.
“The laws of supply and demand still work. If firms are struggling to recruit they will be forced to pay higher wages.”
This improvement in the labour market has been so strong that a growing number of bank economists have changed their views, and are now predicting Lowe will need to raise interest rates earlier than 2024, in response to wage growth and inflation re-emerging.
CBA’s head of Australian economics Gareth Aird, who is more bullish than most, this week predicted that by the end of next year, the underutilisation rate would be low enough to shift the bargaining power between staff and employers in favour of workers.
“The laws of supply and demand still work. If firms are struggling to recruit they will be forced to pay higher wages,” Aird wrote.
He said surveys were already starting to show business labour costs were rising and predicted that by the end of next year, wage growth would hit 2.9 per cent. He argued that would be enough to cause the RBA to lift interest rates from their ultra-low levels.
Lowe has made it clear he thinks we will be waiting longer for a wage recovery. He said in a speech this month that a “laser-like” focus on costs had become “the predominant mindset of many businesses.”
The official statistics also haven’t shown much improvement in wage growth yet, even though businesses are starting to grumble more about staff shortages.
Over time, however, economic logic suggests businesses will need to start bidding up wages more aggressively, as the slack in the labour market is chewed up. Recent trends have raised the chances that this will happen sooner than 2024 – suggesting interest rates may also need to increase before then.
Ross Gittins is on leave.
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