Update on Inflation and Wages– February 2021
In the February statement of Monetary Policy, the RBA confirmed that the cash rate would not be increased until actual inflation is sustainably within the 2 to 3% target range. For this to occur, wages growth would have to be materially higher than it is currently. This will require significant gains in employment and a return to a tight labor market. The RBA does not expect these conditions to be met until 2024 at the earliest, signalling an extended near-term future of 0% interest rates.
The concept of a “tight labor market” is assessed by the RBA as consistent with wages growth of 3.5 – 4.0%, levels which have not been seen since the end of the mining boom in 2012. At its current level, the labor market has sufficient spare capacity to absorb increases in demand for labor without lifting wage levels.
The RBA expects wages growth to lift to 2% by June 2023. The extended duration is largely due to structural headwinds including technological innovation (leading to the greater desirability for capital), increasing labor market competition from globalisation, low productivity growth, low inflationary expectations, and limited bargaining power of unions. These conditions have contributed to the flattening of the Phillips curve in recent years, where the unemployment rate has had to fall even further to trigger increases in inflation. Typically, inflation is driven by wages growth as higher wages encourage increased consumption (demand pull inflation) and raise costs for firms (cost push inflation).
In light of persistent low inflation and the need for continued support as the economy recovers from COVID-19, the RBA is expected to extend its quantitative easing program beyond its scheduled expiry in October 2021. More on that in future articles!