Slowest-ever wages

At first glance, the Q3’17 WPI print was a stable at 0.5%q/q (2.0%y/y) — however once you look at the details it is the lowest ever print for WPI.  The  QoQ non-seasonally adjusted print was 0.8%q/q, reflecting the fact that the minimum wage increase typically biases up the Q3 print.  Once you adjust for the bumper minimum wage hike, it looks like the broad wages pulse slowed to an all time low.

I know, this is a familiar story … but it should have been different this around.  The bumper minimum wage hike (3.3% from 1 July 2017; a full 100bps larger increment than 2016) meant we should have seen a larger increase in wages in Q3.  If everything else had just stayed the same, a print in the [0.6, 0.8] range (where 23/24 forecasters in a Bloomberg Poll were located) ought to have occurred.

The logic is simple — if the general level of wage pressure had been unchanged for the rest of the economy, a 100bps speed up of minimum wages ought to have boosted the QoQ pace of economy wide wage inflation by ~20bps, delivering a 0.7%q/q result.  That we ended up with another ~0.5%q/q suggests that the background level of wage pressure has actually eased in Q3, despite the declining unemployment and underemployment rates.  It challenges our most basic ideas about supply and demand!

I’m very sure this would have been a surprise to the RBA.  In their November SOMP they reported that liaison detected an acceleration of wage pressures in Q3, driven by the larger-than-usual minimum wage hike as well as an improvement in broad based private sector conditions.

On this basis, i think we can peg the RBA’s forecast at 0.7%q/q or o.8%q/q … which means that the RBA just missed on wages by 20bps to 30bps.   This means another delay to their forecast return to their inflation target.  The market is pricing the first full hike in Q1’19 at present … this seems at least a few quarters too early to me.

Most people would regard sustained 2.5%y/y cpi inflation with 2% wages growth as very unlikely. I certainly don’t think the RBA would be comfortable with the outlook for inflation so long as wages growth is below 2.5%.  To forecast core CPI of 2.5% with wages growth below that number would mean forecasting a series of negative productivity shocks … something i’ve never seen before!

Given the recent weakness in the housing market, the outlook for wages matter more than usually for inflation.  As you can see from the below chart, the last five years have been characterised by consumption growth that exceeded the pace of income growth.  I think this was encouraged by a housing wealth effect. This drove the savings rate down 500bps to ~5%.  With the housing boom over, consumption growth will slow toward income growth — and it’s hard to see 2.5% inflation if that happens.

Screen Shot 2017-11-19 at 3.40.58 pm

The only way out of this is wage inflation.  With the housing market under control, the RBA can afford to wait to see a few quarters of wage inflation before starting to tighten.

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9 Responses to Slowest-ever wages

  1. Rajat says:

    Thanks for the post. I agree that based on the SoMP, it must’ve been a surprise to the RBA. When you say, “This means another delay to their forecast return to their inflation target”, does that translate into them now thinking underlying inflation will hit 2% y/y in, say, Dec ’19 instead of Sep ’19? And if so, presumably that’s as late as they can forecast returning to the bottom of the target before having to cut?

    I think the wage data are easier to reconcile with the employment data if one thinks both are driven by nominal demand rather than employment (or, rather, UnN) driving wages as per the New Keynesian model. (After all, we had stronger wages and prices growth in the ’80s even though UnN was higher…) If nominal demand drives both, but one assumes wages are sticky around their medium-term record, then it’s possible to reconcile some jobs growth in recent times with diminishing wage increases. But this alternate view would predict slowing jobs growth, which as you suggest seems contrary to the RBA’s view in the SoMP. The test will be what happens to the labour market over the next 3-6 months.

    Regarding 2% wages growth with 2.5% CPI, I agree it’s improbable, but in theory it could reflect ongoing tobacco excise increases, petrol price rises and energy price rises – none of which reflect domestic demand of course and should be ignored for mon policy purposes. In any case, I don’t think we’ll see too many energy price rises after 1Q18 given the flood in renewable generation investment we’re now seeing and the increased ability of the regulator to lower network tariffs.

    • Ricardo says:

      The current SOMP has trimmed mean inflation returning to 2% in the final quarter of 2019 … so this would push it back into 2020. As you know I prefer the trimmed mean measure and use the numbers in the fan chart. That is their preferred measure of inflation and the only teal point estimates that are published.

  2. nottrampis says:

    I am coming to the point of view that our labour market is too liberalised. We are now getting the US disease.

    • Ricardo says:

      It might well be true that it is too liberal for wage inflation. But that is sort of the same thing as saying we would be more insular if the labour market was more regulated (as it was in the 50s).

  3. nottrampis says:

    Iy is another way of saying too much of productivity improvements is going to capital!

    Why the 50s why not the 90s!!!

    • Ricardo says:

      That is the thing – there isn’t much measured productivity. But I take your point. I chose the 50s as my sense is that this is a global problem caused by the gains made by the truly poor joining our party.

    • Ricardo says:

      To finish that thought – the 50s was a totally closed economy … I don’t think you can be a little bit open. The 90s set us up for today.

  4. nottrampis says:

    I am very much a 90s man and no fan of the 50s. no competition for a start!

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