Award wage lift adds heat to interest rate expectations

Economists and the market have lifted their expectations for RBA interest rate hikes, after a big lift in the award wage.

Upward pressure on wages from the Fair Work decision reinforced expectations that the Reserve Bank, led by Governor Philip Lowe, will need to keep lifting interest rates. Photographer: Patrick Hamilton/Bloomberg

A big lift in minimum and award wages announced by the Fair Work Commission adds to the risk of prices-wages spiral that may lead to even higher interest rates, increasing the risk of a recession.

The 5.75 per cent increase in award wages covering 2.5 million people or about 20 per cent of the workforce exceeded economists’ expectations of a 4-5 per cent increase, and a record 8.6 per cent rise in the national minimum wage covering 184,000 workers also topped an expected 7 per cent lift.

Combined with monthly inflation data this week showing a bigger than expected 6.8 per cent rise in the consumer price index in the year to April, the upward pressure on wages from the Fair Work decision reinforced expectations that the Reserve Bank will need to keep going.

Even after an aggressive 11 interest rate hikes in 12 months that saw the cash rate surge from a record low of 0.1 per cent to a decade high of 3.85 per cent in that time, some economists warned that the RBA will need to lift the cash rate well above 4 per cent to head off a prices-wages spiral.

Cash rate futures implied a near 40 per cent chance of a 25 basis point lift in the cash rate by the central bank at its meeting next Tuesday, up from 21 points on Thursday. Market pricing implied the cash rate will rise about 30 basis points by the time of the RBA’s September meeting.

But ANZ, Capital Economics, Goldman Sachs, Nomura and Royal Bank of Canada economists raised their peak RBA cash rate forecast to 4.35 per cent versus the current level of 3.85 per cent.

AMP Capital chief economist, Shane Oliver, raised his terminal rate forecast to 4.1 per cent.

“A rebound in Australian inflation and the latest minimum and award wage increases unfortunately now make a further RBA rate hike look likely and so we are allowing for another 0.25 per cent increase in the cash rate on Tuesday taking it to 4.1 per cent,” Dr Oliver said.

“Following the April inflation data and the further step in minimum and award wages growth, the risk is now very high that ongoing inflation and wages concerns will see the RBA overtighten and knock the economy off the ‘narrow path’ into recession.”

Jarden chief economist, Carlos Cacho, predicted a peak cash rate of 4.6 per cent by November.

He saw the 5.75 per cent increase in award wages as an “upside risk to both wages and inflation”.

“The other key concern for the RBA is the lack of productivity growth,” Mr Cacho added.

“This means that unit labour costs are rising at over 5 per cent on-year. So even the current relatively modest pace of wages growth is inflationary - this is inconsistent with their target and likely to keep the RBA hawkish. This, along with stubbornly high services inflation, led by large increases in rents, utilities, and insurance, means we still don’t expect RBA cuts until late 2024.”

He said the wages decision will hit business margins, already under pressure from rising input and product costs, and may embolden unions to push for higher wage increases, particularly in sectors with strong union membership like education, health, utilities and transport.

ANZ chief economist, Adam Boyton, said his previous forecast that the cash rate would hit 4.1 per cent was no longer “sufficient to bring inflation back to the target in a reasonable period of time” and that the RBA would lift the cash rate to 4.35 per cent by August.

Nomura senior economist and interest rate strategist, Andrew Ticehurst, also lifted his RBA terminal rate forecast to 4.35 from 4.1 per cent after what he saw as a “large increase” award wages.

Mr Ticehurst said the big increase in the award wage rise was a “deal breaker” versus his expectation of an increase of about 4 per cent, which will likely be “viewed with concern” by the RBA as it.

The award and minimum wage increases “threatens to act as a ‘beacon’ for other workers on enterprise agreements and that the RBA board is likely to worry about a consequent increase in inflation expectations and a further delay in the return of inflation to the target band.

“The RBA had already noted that it was forecasting a four-year period of above target inflation, and we read its communication as suggesting little tolerance for any further delay,” he added.

He also noted that an upside surprise to US non-farm payrolls data on Friday would be an “additional concern to the RBA, as it would raise the possibility of a higher fed funds path, and lower Australian dollar, if the RBA does not respond in kind.”

Royal Bank of Canada chief economist, Su-Lin Ong, also lifted her terminal RBA rate forecast to 4.35 per cent, adding two 25 basis point rate hikes to her previous interest rate forecasts.

“Like its global counterparts, the RBA is assessing whether policy is restrictive enough to ensure inflation returns to target within a reasonable timeframe,” Ms Ong said.

“The extremely tight labour market, rising wages and elevated unit labour costs near 7 per cent are more pressing for policy consideration and by the bank’s own admission, the current cash rate is not overly restrictive. It needs to move higher.”

But Westpac chief economist, Bill Evans, said that while another rate hike is likely to be seriously discussed at next week’s meeting, the RBA is likely to “hold the line.”

“There is too much uncertainty for the RBA Board to raise the cash rate again next week,” he said.

“In particular the outlook for household spending is very worrying especially with in-built lags associated with this unique cycle.”

“An extended pause to allow full evaluation of these lags is the best policy.”

CBA’s head of Australian economics, Gareth Aird, also expected the RBA to stay on hold next week.

He said the wage increases were “broadly in line with what we think the RBA had pencilled in.”

“We believe the domestic economy is now showing sufficient signs of slowing and we expect the RBA board will judge that leaving the cash rate on hold is the appropriate policy move in June,” he said.