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.
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.