A change of Government, even one born out of the upheaval of a marked shift in voting allegiance towards minor parties and independents, will make minimal difference to Australia’s economic outlook in the near-term. The new Government is in with a majority in the lower house it seems. It promised nothing before the election that will alter Australian economic prospects materially in the near-term.
The RBA, in contrast, started with a 25bps hike at its May policy meeting and is providing every indication that it will keep hiking at a leisurely pace. Last week we indicated a pattern of two or three rate hikes followed by a pause to assess the economic impact, taking the cash rate to 1.10% by the end of 2022 and 2.10% by the end of 2023.
Our cash rate forecasts are at least a percentage point lower than financial market forecasts or the forecasts of most other analysts. Our sense is that the market is judging that Australia is facing an inflation problem on par or worse than that faced by the US, otherwise it is hard to explain why US and Australian 2-year bond yields are almost identical with their US counterpart at respectively 2.58% and 2.52% and the 10-year bond yield is at a hefty premium for Australia at 3.39% compared with 2.92% for the US.
Our view is that US inflation (CPI at 8.3% y-o-y in April with underlying inflation at 6.2% y-o-y) is already a tougher task to contain than Australian inflation (CPI 5.1% y-o-y in Q1 with underlying inflation at 3.7% y-o-y). The US economy is also more clearly overheating than the Australian economy. The US unemployment rate at 3.6% in March and April is one notch way from a low point last seen in 1969.
The Australian unemployment rate at 4.0% in February and March is one notch away from a low point last seen in the early 1970s. Where the difference is greatest in potential economic overheating and ongoing inflation is in wage growth running at 5.5% y-o-y and more on all measures in the US against 2.3% y-o-y increase in the wage price index in Q4 2021. Australia’s Q1 will be released this week and may see annual wage growth rise to 2.4% or 2.5% y-o-y.
The US already has fast growing wage growth underpinning future inflation. So far, Australia does not have the same wage-push dynamic for medium-to-longer term inflation. That key difference means that financial markets should adjust rate hike expectations towards relatively less and more measured in Australia compared with the US.
Of course, when forecasting economic growth, inflation and interest rates there are always provisos. The key proviso for Australia is will wage growth remain comparatively low, the surest but least popular way to ensure that inflation settles comparatively low medium-to-longer term. Alternatively, rising wages tied to productivity improvement can also generate moderating inflation over time.
There are several calls for higher wages in Australia, some significant claims soon to be decided by Fair Work Commission (FWC). The 2022 Minimum Wage Case will be decided in June and whatever the FWC decides will apply to the Minimum Wage for the first pay period after July 1st. The ACTU is pressing for a 5.5% rise (covering the most recent annual CPI rise and a little more). If the opinion polls are right regarding the Federal Election next Saturday, the new Government has promised to argue the case for a 5.1% increase to cover the latest annual rise in CPI inflation bloated by several one-off factors that will fall out of the annual calculation over the next year. The one-off factors have already been compensated for in one-off additions to government payments and reductions in tax in the March Budget. Employer groups will argue for a smaller than 5.1% pay rise.
We expect the FWC will grant less than a 5.1% increase to the Minimum Wage recognising the one-off component of currently high inflation is already being compensated.
The tricky issue is that the non-one-off part of annual inflation is running above 3%, (latest underlying inflation rate 3.7% rising above 4% soon on the RBA’s latest forecasts) well above the top of the RBA’s 2-3% target band. If the FWC chooses to grant say a 3.7% pay rise to the Minimum Wage reflecting underlying inflation, it will need to ensure that the pay hike is fenced in to just the Minimum Wage.
The idea that workers should be compensated for recent underlying annual inflation seems fair in principle, but fairness needs to be weighed against the risk of underpinning inflation above the RBA’s target setting the scene for interest rate hikes which if pushed too far, whether by policy design or error, risk tipping the economy into a recession down the track with rising unemployment. Rising unemployment is always unfair in the way it impacts. Often it is those in less secure employment on low pay who lose their jobs in the biggest numbers.
The FWC is likely to be impartial assessing the “fairness” consequences of its Minimum Wage determination. It is also likely to be impartial and consider the facts when presented with arguments that workers’ real wages have been going backwards for several years and that now is the time for catch-up. The CPI and wage price index show that rather than going backwards, real wages have held ground or risen in four of the past five years.
In 2017 the average annual increase in the CPI was 1.9% with private sector wages up 1.9% and public sector wages up 2.4%. In 2018 the positive real wage gap increased with the CPI up 1.9% and private and public sector wages up respectively 2.1% and 2.5%. The positive gap widened further in 2019, CPI 1.6%, private wages 2.3% and public sector wages 2.4% and again in 2020, CPI 0.9% private wages 2.0%, public sector wages 1.6%. It has only been in 2021 beset by repeated covid lockdowns and international supply chain issues that wage growth has slipped behind the CPI, average CPI increase 2.9%, private wages 2.0% public sector 1.6%.
We expect the FWC to review the facts of real wage change over recent years not the myth. The FWC is also likely to take account of government payments compensating for cost-of-living pressure in determining how much of recent high inflation should be passed through to the minimum wage.
Another determination by the FWC following on the heels of the Minimum Wage Case is the Wage Case seeking a 25% pay increase for residential age care employees. Oral hearings will occur on 6th and 7th July with a decision likely shortly after. This case is not about compensating for inflation, but rather the relativity of pay in the sector. Low pay in the sector has contributed to low numbers of care workers seeking employment in the sector and contributed to deteriorating care standards noted by the Royal Commission into Age Care. There is a reasonable likelihood that the FWC will grant a substantial pay increase but probably phased in over several years.
The key wage determinations in June and July will lift wage growth in the second half of 2022, but well shy of wage growth above 5% that has featured in the US since late last year and that is showing little sign of abating. Barring a turn to blindly feeding peak inflation through to wage growth (wage indexation 1970s style revisited) we see Australian inflation peaking lower than in the US, UK, Canada and New Zealand and returning closer to central bank target range more quickly. The RBA is in the enviable position of being able to normalise the cash rate in small steps and slowly at this stage.
Essentially, Australia is growing more strongly than most other advanced economies and is managing that growth outperformance with less inflation than most others. Australia’s comparatively positive economic momentum in the near term will not be altered by a change of government. Even when the new Government does start to legislate change according to the “small target” list of changes promised ahead of the election the impact on economic growth prospects will be small.
It is perhaps an inconvenient truth for the incoming Government that it is inheriting an economy that is in good shape. On Wednesday 1st June, the ABS will release Australia’s Q1 GDP growth and it is likely to show real growth of at least 1% q-o-q. That compares with quarterly GDP growth in Q1 that slipped backwards in the US, and Japan and rose only 0.3% q-o-q in the European Union.
Moreover, Australia has strong growth momentum in Q2, not least from a near fully employed workforce. The April labour force report released last week showed total employment up 4,000 (full-time employment was up 92,400) and the unemployment rate at 3.9%, the lowest reading in 48 years. The strong labour market will continue to underpin household spending, one key support for Australia’s strong economic growth.
Australian households are facing higher cost-of-living challenges but one-time payments and additional tax rebates from the previous Government provide some near-term offset and past build-up of household savings through the pandemic provide ability to keep spending, even if wage growth is not keeping pace with inflation for the time being.
In Q1, real retail spending rose by 1.2% q-o-q. A first look at how retail spending is going early in Q2 will be provided by April retail sales out on Friday. The market consensus forecast is that retail sales rose around 1.0% m-o-m, still robust annualising above 10% y-o-y!
Apart from household spending, business investment spending looks firm as well. The Q1 private new capital expenditure report is out on Thursday and is expected to show a rise of around 1.5% q-o-q after a 1.1% increase in Q4. Business surveys have been showing a lift in businesses expecting to increase capital spending. Business profits have been rising strongly, especially for resource companies benefiting from what has been a problem in many countries overseas, sharply higher commodity prices.
In past cycles of rising commodity prices, the Australian dollar exchange rate has usually risen too, tempering some of the profit gain for Australian commodity exporters. This time, because of investors reacting to uncertainties in the world by buying US dollars, the Australian dollar exchange rate has been comparatively soft allowing almost full flow of much higher export commodity prices denominated in US dollars to feed through to higher Australian company profits.
Australia’s resource companies might be expected to add substantially to the lift in Australian business investment spending that is already in train.
While Australian economic growth prospects look strong for the most-part, one potential soft-patch down the track is housing activity. Housing has been exceptionally strong around Australia for the past two years, but the first signs of a softer turn are showing in Sydney and Melbourne.
The capping out of the house price boom is essentially a response to policy measures by APRA and the RBA that have started to limit the amounts that homebuyers can borrow and added to mortgage servicing costs. APRA’s higher interest servicing buffers on loans from more than a year ago, combined with the RBA abandoning its control of the 3-year bond yield at 0.10% late last year setting the scene for sharp lift in bank’s fixed-rate mortgage interest rates and then this month the start hiking the cash rate have all combined to temper home purchase demand.
The policy squeeze on housing demand is set to continue, partly alleviated perhaps if the new Government gets its low-middle income home buyer scheme up after its first Budget planned for October. It is reasonable to expect that the softness in the Sydney and Melbourne housing markets continues and extends slowly to other capital cities and the regions. Housing activity is likely to be a growing detractor of economic growth later this year, but not enough of a detractor to destroy otherwise strong growth in other sectors.
One reason to expect the housing slowdown to be more wilt than collapse is what we spoke about last week. The RBA is in the enviable position of normalising its cash rate slowly. Wage growth is comparatively low and slow. The Q1 wage price index released last week rose 0.7% q-o-q, 2.4% y-o-y, compared with 0.7% q-o-q, 2.3% y-o-y in Q4 2021. Wage growth may lift faster later this year with key wage claims that will be decided soon, but annual wage growth will not match inflation this side of 2023 providing the RBA with the opportunity to hike in customary 25bps steps (not the 50 bps steps common in higher inflation countries such as Canada, New Zealand, the US and UK) and take pauses occasionally.
All told, Australian economic growth is strong and looks like staying strong the rest of this year at least. Australian inflation is high, but not as high as elsewhere and looks manageable on less policy response than elsewhere. The change of Government will not alter Australia’s economic outlook in the near-term.