Key data will be released this week informing the RBA’s decision when to start hiking the official cash rate. The RBA has indicated repeatedly that actual reported annual inflation consistently inside 2-3% target band is a pre-condition to hiking the cash rate. Moreover, even if inflation is travelling inside or a bit above target band as it was through the second half of 2021 the RBA wants to see annual wage growth that will sustain inflation inside target band before starting to hike.
Annual wage growth is key to timing the first cash rate hike which is why analysts are waiting keenly for the Q4 2021 wage price index report due out on Wednesday. The consensus market forecast has wages increasing 0.7% q-o-q, 2.4% y-o-y compared with 0.6% q-o-q, 2.2% y-o-y in Q3. A Q4 wage outcome at or below market consensus forecast would see the RBA hold fire beyond mid-2022 before hiking. An outcome higher than consensus at 0.8% q-o-q, 2.5% y-o-y or higher would likely bring the RBA into play in May or June.
The year-on-year Q4 wage outcome will be below 3%, less than where the RBA wants to see annual wage growth. Should that alone not give the RBA cause to delay rate hikes? The problem is that the quarter-on-quarter wage increase at 0.7% or above is annualising close to 3% and above.
Also, the tightness in the labour market evident in the unemployment rate holding down at 4.2% in January and likely to travel much lower over the next few months will drive upward wage pressure accelerating quarterly wage pressure. Q1 2022 wage growth looks set to come in higher than Q4 2021, say 0.9% q-o-q or higher, annualising above 3.5% y-o-y.
The warning signs of inflation-supporting wage growth ahead are likely to show in the Q4 wage price index this week. But the RBA, like many of its international peers over recent years, has become reactive setting monetary policy refusing to hike unusually low official interest rates until it is proven in wage and inflation data that sustainably higher inflation has arrived.
After the period of high inflation through the 1970s and 1980s central banks prioritised containing inflation. As it turned out the period extending from the early 1990s to the beginning of the Covid pandemic in early 2020 was a period of disinflation. The peak of each cyclical lift in inflation was lower than the previous peak and the cycle inflation low points diminished too.
Many factors contributed to the 30 years of disinflation including ageing populations creating a surplus savings over investment in developed economies; globalisation of production including employment unleashing cheap labour; and rapid technological change.
Adding to the disinflationary mix, central banks were haunted by the spectre of runaway inflation from the 1970s and 1980s and adopted pre-emptive policies starting to tighten on any prospective lift in inflation. In the RBA’s case, in the
1990s and early 2000s if inflation was low but their in-house economic forecasts pointed to above-target inflation, that was sufficient cause to start tightening.
Central banks, including the RBA, started to realise through the 2010s the strength of long-term disinflationary forces. Setting monetary policy pre-emptively to deal with the first flicker of cyclical inflation was unnecessary and worse cut-off strong economic growth prematurely denying opportunity to achieve full employment. Pre-emptive policy setting gave way to reactive policy setting based on the view that longer-term disinflationary forces would prevail over even quite high near-term inflation. Central banks can take their time before hiking.
While some longer-term disinflationary forces may re-assert, others appear to be not as strong as they were. Globalisation, for example, has been affected by the Covid Pandemic and more than temporarily. Labour flows across borders have been affected. Out-sourcing of production offshore to reduce costs has become more limited and in some cases on-shoring is occurring to increase security of supply.
The Pandemic has also increased the willingness of governments to spend money, pick and back “winners” in the economy and impose regulations, all factors increasing demand while reducing the efficiency of production and adding to price pressures.
Supply chain disruption has been held up as the main cause of the big lift in inflation over the past year and more and once the problems subside inflation should diminish nearer to its old low inflation trend. Yet the supply chain problems are correcting more slowly than hoped and may reassert on geopolitical disruption to energy and food supplies or a new Covid variant and wave of infection.
In any case, other inflation boosting factors are in play, notably aggregate demand in the economy primed to rise and stretch supply and of course back to the beginning wage growth just starting to hint at support for higher inflation.
The latest Q4 wage price index tells how wages were travelling in the last three months of 2021. The labour market conditions that delivered the wage rise in Q4 occurred at least three months earlier. In short, the wage setting conditions during the second half of 2021 are driving a possible rate hike the RBA may deliver at earliest in May or June this year.
This certainly fits the bill of reactive policy-making – about a year reactive to the developing inflation problem. The RBA still has some arguments to support the delay – a possible cavalry charge of workers from overseas to add to labour supply and stem the rise in wages or something unforeseen from stage left that cuts growth in aggregate demand – but these potential changes are outweighed by what has happened through the second half of 2021, measured inflation running within target band and above and wage growth threatening to keep it there.
Take a walk down memory lane to Q4 last year on Wednesday with the release of the wage price index. What wages did then will light the fuse on the first official interest rate hike. The higher the quarterly wage rise relative to 0.7% q-o-q expectation the shorter the fuse will be.