Rate hike risk from wages flies under the radar

The chance of the RBA lifting the cash rate again may be higher than implied by financial markets after the NAB monthly business survey.

Are financial markets accurately reflecting the risk of further interest rate rises in Australia?

Domestic interest rate jitters receded further after the RBA left rates on hold again this month.

Despite worrisome signs in NAB’s monthly business survey that the wage rises announced by the Fair Work Commission’s review in early June caused a sharp and immediate reacceleration in wages and prices after the decision took effect on July 1, the cash rate futures market implied a peak of 4.185 per cent by February, equivalent to a 34 per cent chance of another 25-basis-point rate rise.

The June quarter inflation rate was 6 per cent on-year, versus the target of 2-3 per cent.

As well as continued resilience in business conditions, the survey showed labour cost growth jumped to 3.7 pent cent in quarterly equivalent terms (14.8 per cent annualised), versus 2.6 per cent in June.

Final price growth jumped to 2 per cent, from 1 per cent in quarterly terms, with retail up 2.6 per cent, from 2.2 per cent, and recreational & personal services up 2.9 per cent, from 1.2 per cent.

The market and the central bank are assuming these pressures will weaken.

Wages growth is expected to level off at a 4 per cent annualised pace, which the RBA has said will be consistent with inflation falling to the 2-3 per cent target band by late 2025, assuming that productivity recovers to its pre-­pandemic trend over the next year or so.

The RBA acted pre-emptively to head off “upside risks to the inflation outlook” when it lifted the cash target by 25 basis points to a decade high of 4.1 per cent in June.

It has left rates on hold since then, marking its first two-month pause since it started lifting rates last year.

Minutes of the June meeting said board members “observed that it was understandable that the lowest-paid workers would be compensated for high inflation, but that it would be concerning if wages across a broad range of jobs were to become implicitly indexed to high inflation”. But the RBA had no way of knowing at the time if that additional 25-basis-point rate rise was enough.

The next NAB survey will come on September 5, the same day the RBA board meets again.

If wage and prices strength lingers in the NAB survey, it will make for a tense RBA meeting indeed. Any signs of increases in wages costs related to award and minimum wages won’t show up in the wage price index data until the September quarter data is released in November.

Commonwealth Bank expects the activity side of the economy to be weak enough by then to prevent further RBA rate rises.

“However any signs of lingering price and wages strength could add to the risk of a later start to our current early rate cut call of March,” CBA economist Harry Ottley said.

If the RBA sees a “smoking gun” for large and rapid increases in wages and prices evident in two consecutive NAB monthly business surveys, it may not want to wait until November.

With consumer confidence extremely weak and business confidence below average, alongside wage and price pressures, economists are also starting to talk about the risk of stagflation. But the policy prescription would be to get out in front of such inflation risks.

“I have a suspicion that Tuesday’s release of the NAB Monthly Business Survey may have occasioned some amount of hand-wringing at the top end of Martin Place,” GSFM investment strategist Steven Miller said. “I am a little surprised at an apparent lack of hand-wringing in the markets.”

While some reacceleration in wages and prices shouldn’t surprise after the Fair Work Commission wage review decision took effect, Mr Miller doubts that it was adequately reflected in the RBA’s latest economic forecasts in its Statement on Monetary Policy last week.

He says that decision is likely to see inflation in Australia exhibit a greater degree of “stickiness” versus other developed countries.

While there are risks in the other direction, such as indications of weaker activity growth and ongoing weakness in China, those risks are possibly better understood.

There is also the notion that despite inflation risks, rising recession risks should lead to an indefinite delay in any further policy rate rise, but Mr Miller says that would be a policy “mistake”.

“The lesson from the ’70s is that any delay on the part of a central bank in articulating a coherent and firm response to an inflation threat only heightens the risk of a more damaging macroeconomic dislocation in terms of activity and employment down the track,” Mr Miller said.

He said he saw a “clear and present danger” in terms of the risk of a prices-wages spiral stemming from the reacceleration of labour costs and prices evident in the NAB survey.

“The RBA has been a ‘laggard’ when it comes to tightening and where Australia’s relative inflation performance has been slipping,” he said. “That is a conse­quence of the RBA showing a greater tolerance in terms of the expected timeframe attaching to the return of inflation to target than some other central banks.

“It may already mean that the impact on employment and activity growth may well end up being greater than would otherwise have been necessary had the RBA shown some greater application to inflation containment earlier in the piece.”

His comments came as ANZ-observed spending fell 8 per cent on-year in the week to August 5.

“The ongoing softness in ANZ-observed spending, alongside the weak ABS household spending indicator and negative retail volumes print, suggests the RBA’s efforts to curb spending are working,” ANZ’s Madeline Dunk and Adelaide Timbrell said.