Fair Work Commission wage rise puts pressure on rates as productivity declines

The Fair Work Commission decision is a Pyrrhic victory for workers as the Reserve Bank mulls another increase in the policy rate.

Friday’s announcement by the Fair Work Commission of a 5.75 per cent increase for both minimum and award wages will indubitably increase the pressure on the Reserve Bank board to further increase the policy rate when it meets on Tuesday.

A decision to realign the minimum wage to a higher level in the award wage structure means the effective increase in the minimum wage is 8.6 per cent.

The FWC decision was higher than that assumed by the RBA, implying considerable upside risk to its recent forecast of a 4 per cent peak in the Wage Price Index, a measure that due to “classification creep” might well understate actual wage growth.

Even if the RBA board opts to “pause” in June, it seems highly likely that some increase (or increases) will follow later in the year.

The FWC decision comes after the release of the April Monthly Consumer Price Index, which was surprisingly high.

The CPI indicator rose 6.8 per cent in the year to April, versus an expected 6.4 per cent.

This was after RBA governor Philip Lowe told the Senate estimates committee that any further increases in the policy rate were “data-dependent”.

That makes next week’s RBA board meeting ‘‘live’’ when it comes to the prospect of a further increase in the policy rate. That is the case despite the Chinese economy looking a little more vulnerable in the wake of a weak activity data in May.

With a real prospect of a ripple beyond the minimum/award wage complex, the FWC decision is likely to intensify inflation pressures, particularly if productivity growth continues to languish. Moreover, such an outcome is unlikely to achieve the stated aim of lifting living standards of low-paid workers, as any gains are eaten up by higher living costs through inflation and – ultimately – higher interest rates and/or higher unemployment.

In his appearance before the Senate estimates committee this week, governor Lowe emphasised that inflation pressures need not be so much the consequence of wage growth alone but also a reflection of poor productivity performance.

The December quarter national accounts revealed a steep fall in productivity: gross domestic product (GDP) per hour worked fell 3.5 per cent over the year to the December quarter of 2022, meaning that with wages increasing at around 4 per cent, unit labour costs (the most relevant labour cost gauge for inflation) increased by more than 7 per cent over the same period. The RBA board May meeting minutes implied that poor productivity growth was in part behind the decision to increase the policy rate at that meeting, given the need “to ensure consistency of the wages growth forecast with the bank’s inflation forecast”. In the absence of a surprising bounce in productivity in the March quarter national accounts, the FWC decision will further stretch that “consistency”.

Inconveniently, the March quarter national accounts are released a day after the next scheduled RBA board meeting on June 6, meaning the national accounts-based wage and productivity data will not be seen by the RBA board until the board meeting scheduled for July 4.

Recent changes in the regulatory environment, particularly in relation to the wage-setting and industrial relations framework, run the risk of entrenching higher inflation in Australia compared to elsewhere, particularly as they weaken the link between productivity improvements and real and nominal wage growth.

These are domestic developments that will be of some concern to the RBA as it wrestles with the slow return of inflation to target.

As the governor has mentioned, the path between the vanquishing of inflation and avoiding a recession, or at least a sharp growth slowdown, is a narrow one.

The FWC decision and the “unintended consequences” of labour regulation may make that path an even narrower one. There are also global structural currents that make elevated developed-country inflation rates more “sticky”.

The globalisation of labour supply (after the fall of the Berlin Wall and the “export” of labour from large emerging market economies such as China and India) is abating; globalisation of goods markets is in retreat as governments everywhere introduce protectionist measures under the guise of “industrial policy” and “national champions”; domestic regulation of markets is increasing in scope (leading to upward price pressures); and baby boomer workforce participation is declining (limiting labour supply and lifting wages).

The transition to clean energy involves ongoing costs to business, which is not to say it is undesirable, but it does complicate the task for inflation-focused central banks.

To be fair, Australia’s high immigration rate somewhat mitigates these influences over the longer-term but won’t eradicate them.

Indeed, in the short term, pressure on housing rents from immigration may tip inflation risks the other way.

The foregoing leads me to conjecture that the policy rate will need to have a “4 handle” to bring inflation back to the 2 to 3 per cent target zone within an acceptable timeframe while minimising the dislocation in activity growth and employment.

If the RBA board is of a similar mind, it might take the view that it is better to arrive at the terminal rate quickly and a rate increase is on the cards at the June meeting.

And it may not be the last in this cycle.

Stephen Miller is an investment strategist with GSFM.