Is the RBA's model broken or merely bent as wages wither and jobs grow?


May 15, 2019 11:55:44

The Reserve Bank would have studied the recent snapshot of Australia’s workplaces with decidedly mixed feelings.

This week:

  • Construction work done third quarter data (Thursday)
  • RBA minutes and RBA governor speech (Tuesday)
  • Thanksgiving Day closes Wall Street (Thursday)

Unemployment ticking down another notch was very much going to plan.

Wages growth stuck near its historic low was not. The trend is not new, nor localised to the RBA’s patch.

It is also not supposed to happen according to the Phillips curve, one of the core beliefs of the big, inflation-targeting central banks worldwide.

Being at the heart of global monetary policy, the Phillips curve has driven interest rate movements, and by extension the cost of paying off our home loans and credit cards.

But if the curve is not broken already, it bent badly out shape according to UBS economist George Tharenou.

This central bank article of faith was drawn up by a Kiwi economist A.W. Phillips in 1958.

In its simplest form it postulates as unemployment falls, wages and inflation rise.

It is an attempt to put some intellectual rigour and numbers to the rather hazy NAIRU (non-accelerating inflation rate of unemployment) — or the rate below which unemployment should not fall without causing a wages breakout and rampant inflation.

To be fair to the RBA, Australia hasn’t hit that theoretical point yet. But it is close.

Australia’s NAIRU is currently assumed to be around 5 per cent, compared to the 5.4 per cent the ABS came up with last week.

A look at the US, where unemployment is now at 4.1 per cent, or the UK, where it fell to a more than four-decade low of 4.3 per cent, wage growth barely keeps up with inflation.

It shows something seems to be out of whack with central bank thinking.

Six reasons for the RBA to be happy, one why it is not

Mr Tharenou has tallied up a list of why the RBA expects wages growth to rebound.

  • Jobs booming to a post-GFC-high of +3 per cent annually
  • Unemployment dropping to a more than four-year low of 5.4 per cent, only modestly above NAIRU
  • The minimum wage by rose by 3.3 per cent, the most in six years, directly adding around 0.25 percentage points to overall wages
  • Record business conditions
  • A rebound of commodity prices which lifted profits, exports and nominal GDP by 3.5-to-4 points over the past year, and put upward pressure on inflation
  • A synchronised pick up of global GDP which is likely to continue ahead

All terrific, but as Mr Tharenou notes, despite so many “positive shocks” wage growth remains near a record low and will continue to disappoint, stagnating around 2 per cent growth.

Last month RBA deputy governor Guy Debelle expressed some unease about the expectation that under the laws of economics, wages would now start to rise.

He pointed out in the US, Germany and Japan wage and price inflation remained weak as unemployment tumbled below previous estimates of NAIRU.

“This can, presumably, only go on for so long, as eventually the laws of supply and demand mean that as new workers become increasingly hard to find, companies will actually have to pay higher wages to fill jobs,” Dr Debelle said.

Mr Tharenou has his doubts.

“There is also still broad weakness of WPI [wage price index] across most industries… coupled with an even greater relative extent of weakness in average earnings, which are flat,” Mr Tharenou said.

This, along with Enterprise Bargaining Agreements (EBAs) collapsing to a record low means it is unlikely inflation will get back to the RBA’s 2-to-3 per cent target band any time soon.

The expectation of low inflation is also keeping wage pressure in check, as is strong population growth of around 3 per cent annually, driven in large part by a rebound in net migration.

As Mr Tharenou points out, migration is increasing aggregate demand — especially for residential rental accommodation — but it is also a significant “positive labour supply shock”, which is likely to cap wages growth for some time yet.

“In the past three years, the unemployment rate has clearly trended down, but wages still weakened further to new record lows,” he said.

“The Phillips curve in Australia appears not just bent, but is arguably becoming broken.”

Weak wage growth now on RBA agenda

Market Economics managing director Stephen Koukoulas said the world is still probably five years away from finding out the full impact of stubbornly low wage growth.

“The resurgence of globalisation and the impact of technology — something like Uber versus taxis, low inflation but low wages — is phenomenal for productivity but bad for workers,” Mr Koukoulas said.

Mr Koukoulas, who helped develop the closest thing Australia has to an monthly measure of inflation in his days at investment bank TD-Securities, said the RBA by forecasting underlying inflation won’t get above 2 per cent before 2019 — the bottom of its target band — does not have any margin for error.

Low wage growth is one of the key drivers behind the optimistic business/pessimistic consumer paradox. It may have boosted profits, but it has eroded buying power and has forced households to raid savings to pay for day-to-day essentials.

“You can only fund consumption out of household savings for so long,” Mr Koukoulas observed.

When household spending dries up, so will the biggest driver in the economy and business conditions and confidence may well topple from their current lofty heights too.

The RBA now seems to be shuffling low wage growth up its list worries, having for long fretted about asset bubbles hoping that falling unemployment would do its job as economic orthodoxy and the Phillips curve suggested it would.

Judging by Dr Debelle’s recent speech on uncertainty, the RBA still hopes the Phillips curve will deliver, but perhaps with less conviction than before.

“Our forecast is that spare capacity [unemployment] will be gradually reduced in the period ahead,” he told a gathering of economists late last month.

“But, as it is reduced, we will be alert to the possibility that these developments we see in other labour markets, in terms of subdued inflation in the face of minimal spare capacity, occur here too.”

Could be time for a new model.

Markets weaken on tax scepticism

Wall Street dragged the rest of the world’s markets down on Friday over its anxieties about US tax changes.

Those anxieties are likely to translate to a mildly negative start to the week on the ASX.

Markets on Friday’s close:

  • ASX SPI 200 futures -0.1pc at 5,959, ASX 200 (Friday’s close) +0.2pc at 5,957
  • AUD: 75.65 US cents, 64.13 euro cents, 57.24 British pence, 84.77 Japanese yen, $NZ1.11
  • US: Dow Jones -0.4pc at 23,358, S&P500 -0.3pc at 2,579, NASDAQ -0.2pc at 6,782
  • Europe: FTSE -0.1pc at 7,381 DAX -0.4pc at 12,994 Euro Stoxx50 -0.5pc at 3,547
  • Commodities: Brent oil +2.2pc at $US62.72/barrel, Gold +1.3pc at $US1,294/ounce, Iron ore +0.5pc at $US62.80

On Capitol Hill House of Representatives republicans voted for their tax bill.

That is normally a promising start — except when their party colleagues in the Senate have different tax changes in mind.

That uncertainty continues to weigh on markets with global equities down for the second successive week.

Just how much impact the tax fracas is having is difficult to assess, apart from brokers grumbling about it.

Certainly, it is not helping trading sentiment.

Over the weekend J.P. Morgan’s strategy head John Normand argued US tax was just one of many spoilers hitting the market at the moment.

You can throw in weaker-than-expected China data, a Russian rethink on extending oil cuts into the mix as well.

Mr Normand said much of the US tax debate is already priced in and there wasn’t a lot of optimism in it anyway.

On China’s slowdown, it was also a pretty familiar riff, as was the uncertainty about the oil deal.

Mr Normand’s overall take?

“Not much seems discounted — most markets are moving on growth and inflation, not Washington,” he said.

Construction may be bloated by gas

It is a fairly quiet week on the data front with third-quarter construction work (Wednesday) — an early piece of the next GDP puzzle — the only top shelf offering.

The previous reading was bloated by the technical inclusion of Darwin’s Central Processing Facility. However, as NAB’s David de Garis noted there was no net GDP impact given it was imported.

That gas story may well be repeated this quarter with the Prelude floating LNG platform arriving in Australian waters in July while the Ichthys’ floating production facility arrived in August.

While the consensus call is construction work will be down around 2 per cent over the quarter, NAB has a 14 per cent rise pencilled in. But once again not a positive for GDP as both floating facilities were imported.

Mr de Garis said closer attention should be paid to the LNG-unrelated residential and non-residential building and public sector engineering work done.

“We expect it to have supported growth and represent still strong domestic construction patterns,” he said.

“Anecdotally, with a very long period of dry weather in Queensland and NSW, there were minimal interruptions during Q3.”

Overseas is too pretty quiet too, not helped by Thanksgiving Day in the US on Thursday taking a big chunk of the trading week out.


Date Event Forecast



RBA speech Head of financial stability Jonathan Kearns at the Aus-China property developers conference



RBA minutes Minutes from the November meeting where rates were kept on hold
RBA speech Governor Philp Lowe speaks to business economists
Graincorp FY results Had a big year last year, focus may be on a much smaller crop this year



Construction work Q3: Could be affected by the arrival of an LNG rig. Forecasts range from -2pc to +14pc
Skilled vacancies Oct: Flat



Woolworth AGM Woolies is fighting back, but investors will want to hear about the impact of Amazon


Date Event Forecast



EU: ECB speech ECP president Mario Draghi in Brussels



US: Existing home sales Oct: Fairly steady



US: Fed speech Chair Jane Yellen speaks
US: Fed minutes Minutes from this months meeting where rates were kept on hold
US Durable goods Oct: A measure of business investment, may be softer



US: Thanksgiving Day holiday National holiday. Bad news for turkeys.
EU: PMI Nov: Measures of manufacturing & services activity. Both expanding



US: Manufacturing PMI Nov: Activity still expanding
US: Black Friday Big shopping day, important for consumer spending









First posted

May 15, 2019 11:36:58

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