When to worry about wages

06 April 2011

Wages growth is quickly heading back towards 4 per cent but policymakers are not yet concerned that this is feeding broader inflationary pressures in the economy.  One reason for this is that, to date, the escalation in wages has been confined to a small number of industries, rather than being widespread throughout the economy.  And while we expect to see ongoing divergences between different sectors, overall wage pressures are likely to broaden.  And when this occurs, policymakers are likely to be a lot more worried about wages.  For this reason the dispersion of wage outcomes will be an important factor to watch.

The annual pace of wages growth is running at just below 4 per cent.  And while policymakers are not ringing the alarm bells just yet, ongoing strength in labour market conditions suggest that wages pressures will provide an upside risk to inflation over the next 12-24 months.  Highlighting that this is on the Reserve Bank’s radar screens, Governor Glenn Stevens made the following comments after the March monetary policy Board meeting.

“Reports of skills shortages remain confined, at this point, to the resources and related sectors.  After the significant decline in 2009, growth in wages has returned to rates seen prior to the downturn”.

So, there are two key issues here.  First, after slowing during the global economic downturn, wages growth has quickly recovered to a similar level to that prevailing in 2007-08.  At this time, the wage cost index was growing at an annual pace of around 4.25 per cent and policymakers were alert to the inflationary implications of this.  But, with wages growth rapidly approaching 4 per cent once again, why isn’t the RBA pressing the alarm bell now?

In our view, this relates to the second point from the above quote.  That is that “at this point” wage pressures and skilled shortages are confined to the resources and related sectors.  And, this highlights that the dispersion of wage outcomes will be a key factor to watch.

The clear difference between now and 2007-08 is that more than half of the industries measured experienced wages growth above 4 per cent in that earlier period, whereas only about 1/3 of industries are experiencing high wage outcomes now.

Unsurprisingly, the largest gains have been evident in the mining industry as well as the related ‘professional, scientific and technical services’ sector, both of which recorded wages growth of 4.6 per cent over 2010.  In contrast the real estate (2.9 per cent Year Over Year) and retail (3.3 per cent Year Over Year) sectors experienced more modest gains.  This is one of the key features of a two-speed economy.

Going forward, we expect these divergences to widen further, but that should be driven more by a faster increase in the mining sector, rather than by a moderation in the slower parts of the economy.  Indeed, while the gap between sectors will widen, the mobility of labour means that overall wage pressures are likely to broaden, as was evident during 2007-08.  And, it will be at that point that policymakers become far more concerned with wage price movements.

With the dispersion of wages growth in mind, it is also helpful to look at some of the potential ‘hot-spots’ for wages growth in the year ahead.  One way to assess this is to look at those areas that are exhibiting labour shortages.  For example, male unemployment in both NSW and WA is below 4.5 per cent, suggesting that wages could rise quickly in these areas.

For WA in particular, the anticipated upswing in business investment within the mining sector means that demand for labour will remain robust.  And, with a limited pool of workers, wages pressures will continue to build.

The bottom line is that there are certain areas and sectors within the economy that are likely to experience significant wages pressures in the year ahead.  But, from a policy perspective, the RBA have made it clear that it will take a broader escalation in wage costs before they need to respond with higher interest rates.  And, in this respect, the dispersion of wage outcomes will be an important factor to watch.