The recent surge in inflation both domestically and globally is well known, with Australian annual headline inflation increasing to 5.1% over the year to March (the highest in 22 years) and the trimmed mean (the Reserve Bank’s preferred underlying inflation measure) at 3.7% per annum, well above the 2-3% inflation target and the highest rate since 2009. Wages have not matched the pick-up in consumer prices so far, which means that consumers are now feeling a real wage decline. We expect wages growth to reach close to 3.5% by the end of the year (from 2.3% as at December 2021). We get the March quarter wages data this week on Wednesday (18th May) which will provide some more direction for RBA rate hike expectations. We outline our outlook for wages in this Econosights.
Labour supply has risen
The supply of labour (or the number of people available to work) has risen in Australia over the past 2½ years, with the participation rate (the share of the labour market over the total working age population) now at 66.4% (a record high), versus the pre-Covid high of 66%. Higher labour force particiaption is a result of strong demand from business due to the quick recovery in the economy from the pandemic and a fall in the availability of short-term foregin workers (which are not captured in the Australian employment figures) because of the closed borders. The rise in labour supply has played a role in constraining wages growth.
This is different to the US where labour supply has not gotten back to its pre-covid levels (see the chart below) leading to stronger US wages growth (currently tracking at 5.5% per annum, compared to 3% before the pandemic).
Spare capacity and wages growth
The strong pace of employment growth has decreased spare capacity in the labour market. Labour underutilisation (the unemployment rate plus the unemployment rate) has decreased to 10.3%, well below the pre-Covid average of ~14% and the lowest level since 2008 (see the chart below). A fall in spare capacity should put upwards pressure on wages growth. Business surveys have been showing a big lift in labour costs over recent months.
Leading indicators of employment growth (such as job advertisments and business hiring intenions) remain strong which should see employment growth remain elevated, put more downward pressure on the unemployment rate and reduce labour market spare capacity even futher. On our measure of the job openings rate (job vacancies as a share of employment and job openings), a common labour market measure used in the US, job openings have risen to 2.9% around a record high and well above the pre-pandemic levels of ~2%.
This argues for further growth in employment, a lower unemployment rate (we expect it to bottom at 3.3% by the end of the year, its lowest level since 1976) and higher wages growth.
Wages growth across industries
The closure of the international border caused a big disruption to industries who rely on skilled migrants and short-term workers to fill employment gaps. Theoretically, shortages of workers should put upwards pressure on wages if firms have to compete for staff.
Job openings data by industry can be an indicator of worker shortages, as high vacancies may be a sign that firms have difficulties in filling jobs. National job openings are 2.9% (as a share of total employment and job openings) but are highest in construction (20%, well up from 10% pre-Covid) and manufacturing (15% versus 5% pre-Covid). High vacancies reflect the boom in these industries, which have both had a big increase in demand over the past 2½ years. Both industries only have a low to moderate share of short-term workers.
Across the industries that have the highest reliance on short-term foreign workers (measured by the number of employees who are recent arrivals as a share of employment), job openings have mostly risen since the start of the pandemic. The job openings rate in accomodation and food services is high at over 13% versus ~4.5% pre-covid, administration & support is at 13% a little bit above the 12% pre-covid, professional services is at 18% compared to 11% pre-covid while transport, postal and warehousing has a low job openings rate of 1% which hasn’t moved much since 2020.
The flow-through to higher wages from worker shortages is not very evident in the data which could be becaue of lags in the enterprise bargaining and award systems (wages inertia). Wages in accomodation & food services have picked up significantly (up by 3.5% over the year to December) but this reflects prior weakness in 2020 (when wages in the industry actually fell), professional, scientific and technical services wages growth has been a tad firmer than average at 2.5% per annum, transport, postal and warehousing wages growth remains low at 1.8% per annum and administration and support services wages growth is also low (2% per annum).
If the closure of the international border didn’t have a significant upwards impact on wages across industries most reliant on immigrants, then the resumption of international arrivals should not put too much downward pressure on wages. So far, the pace of arrivals has been slow to restart (see the chart below).
Wages growth is expected to pick up in 2022/23 from a tighter labour market (as the underutilisation rate has fallen to its lowest level since 2008), a lift in the minimum wage, larger pay rises for public sector health care workers and higher inflation which will urge employees to demand higher wage increases. The high inflation environment and the expected pick-up in wages growth should see the RBA lift the cash rate further and we expect the cash rate to end the year at 2% and 2.5% by mid-2023. If wages growth is slower to pick-up, the RBA may be less aggressive in its tightening cycle.
The opening of international borders could see a reduction in job vacancies but this is unlikely to put too much downward pressure on wages as there is not much evidence to suggest that wages growth increased significantly over the few years of the pandemic in industries that are most reliant on temporary foreign workers.
The pick-up in wages growth is unlikely to match the lift in inflation (we see wages running close to 3.5% by the end of the year and headline inflation to be at 6%) which means that consumers will still be facing real wage declines until inflation slows (we see inflation declining to around 3.3% by mid-2023) which is negative for consumer spending.
Economist – Investment Strategy & Dynamic Markets