Last week the RBA produced its latest set of economic forecasts in the quarterly Statement on Monetary Statement (MPS). This week, Commonwealth Treasury’s latest economic forecasts will be revealed when Treasurer, Jim Chalmers, brings down the 2023-24 Budget. Both sets of forecasts are likely to be similar showing slowing economic growth and declining inflation, but are also likely to show small differences relating to forecast wage growth and inflation. Those small differences may influence how high the RBA will need to push up the cash rate to contain inflation.
The RBA’s latest forecasts show annual growth in the wage price index peaking at 4.0% y-o-y in Q4 2013, revised downwards from 4.2% in the February 2023 MPS forecasts. CPI inflation is forecast to come down from 7.0% in Q1 2023 to 4.5% Q4 2023, a forecast revised downwards from 4.8% in the February MPS. The RBA is still forecasting negative real wage growth in Q4 2023, -0.5% y-o-y against -0.6% in the February forecasts.
The RBA’s forecasts beyond this year show CPI inflation declining to 3.2% y-o-y in Q4 2024 (unchanged from the February MPS forecast) and in the furthest forecast for Q2 2025, to 3.0% (also unchanged from the February MPS forecast). The wage price index forecasts are 3.8% y-o-y for Q4 2024 (4.0% in the February MPS) and 3.7% in Q2 2025 (3.8% in the February MPS). Real wage growth turns positive in the RBA’s forecasts but lifting to only 0.6% y-o-y in Q4 2024 and 0.7% in Q2 in Q2 2025.
It is worth noting that nominal annual wage growth is falling in the RBA’s forecasts after the 4.0% y-o-y forecast peak in Q4 this year and it is their forecast that CPI inflation will fall at a faster pace than wage growth through 2024 and the first half of 2025 that returns real wage growth to positive territory.
The RBA’s decision to hike the cash rate last week another 25bps to 3.85% and indicate that it may need to lift rates further took account of these latest inflation and wage forecasts. The undeclared message in the RBA’s inflation and wage forecasts is that while inflation is falling it is still likely to take a long time to get back to target and annual wage growth even if it peaks at 4% at the end of this year and starts to recede is right on the boundary of making target inflation unachievable in a reasonable time frame.
The RBA could become less concerned about wage growth if low productivity improves. If businesses show signs of investing more (currently the signs are pointing towards businesses becoming more cautious) improving productivity would permit either more certainty that inflation will come down or allow for higher real wage growth in 2024 and 2025 with inflation still receding towards the RBA’s 2-3% inflation target.
Equally, the RBA could become more concerned about wage growth if nominal wage growth starts to run faster than forecast reflecting just inflation catch-up and no improvement in productivity. The RBA after the latest rate hike is watching economic developments – the strength of demand in the economy and how that plays in terms of affecting labour market tightness and pressure on wages. It has its finger on the trigger for another rate hike, but could relax that finger if it see signs that growth in demand is continuing to moderate and that labour market conditions are starting to ease.
That takes us to Commonwealth Treasury’s economic forecasts in the Budget next week. There will be some similarity to the RBA’s forecasts although it likely that the Budget forecasts will show a little less CPI inflation in 2023-24 and 2024-25 than in the RBA’s forecasts with a little higher wage growth showing a more distinct lift in real wage growth starting early in 2024.
The Government and the Treasurer are working to deliver an election promise of delivering higher wages to help combat the “cost-of-living crisis”, high inflation by another name. Higher wage growth without higher productivity, however, would normally tend to work against getting inflation down.
The Budget tomorrow night will try to break the nexus between higher wages perpetuating inflation. The money spent on cost-of-living support initiatives -a centrepiece of the Budget is likely to be up to $500 payments for some households – will be accounted for by the Australian Statistician as a reduction in some components of the CPI such as household energy costs, but depending upon how the initiatives are funded they may serve to keep demand stronger than would have been the case otherwise.
This boost to demand ultimately generates more price pressure than would otherwise be the case down the track. Also, unless the $500 payments are repeated next year, the base effect comes into play in the annual inflation reading – the reduction in inflation this year turns to an equivalent boost to the inflation reading next year.
If the Government is to assist the fight against inflation, it must ensure that its own spending and taxing plans do not boost demand in the economy over the next year or so. This requirement flies in the face of “cost-of-living” relief that will tend to support demand as well as higher wages unless supported by productivity improvement.
To the extent that it is implied in the Budget on Tuesday that higher wages in the near-term are part of the answer to addressing the cost-of-living crisis, the tea leaves say there is a risk that the RBA may find more reason to worry its own wage and inflation forecasts are pitched too low. The RBA may have another reason to hike the cash rate further and keep it higher for longer.