The Reserve Bank expects a couple of tough years for Australians, with real wages continuing to fall as inflation persists and unemployment starts to rise.
Key points:
- RBA raises its inflation forecasts, with a peak of 8 per cent in December with the CPI still growing at 3.2 per cent at the end of 2024
- Wages growth is expected to near 4 per cent by late 2024, meaning it will take until the second half of that year before workers see a real pay rise
- Economic growth is expected to halve next year and remain at 1.5 per cent the year after as household consumption growth slows
Earlier this week, the bank added more pain to mortgage borrowers, with a 0.25 of a percentage point rate rise taking the cash rate to 2.85 per cent, having been just 0.1 per cent at the start of May.
That move will push many variable mortgage interest rates well above 5 per cent, although there are still some mortgages offering rates below 4.5 per cent.
In its latest Statement on Monetary Policy, released every three months, the bank has presented its updated forecasts on the economy.
While Reserve Bank of Australia (RBA) governor Philip Lowe flagged the short-term increase in inflation forecasts for the end of this year from 7.8 to 8 per cent in a speech earlier this week, the bank also predicts inflation will persist longer than previously thought.
While its previous forecasts had consumer price rises falling back to the top of the 2-3 per cent target range by December 2024, the bank now expects annual price rises to remain above that level at 3.2 per cent.
The RBA is hopeful inflation will return to its target range in 2025.
This forecast is based on an assumption of the cash rate made using a combination of market pricing and economist forecasts, which would probably see the cash rate peaking at 3.6 per cent or more.
Westpac’s chief economist Bill Evans warned that allowing inflation to run above the target range for so long would risk it becoming even more entrenched.
“It is very rare for the RBA’s ‘out year’ inflation forecast to be above its target range — the only other instances being when major tax changes were set to boost the CPI (the carbon tax in 2011 and the GST in 2000),” he wrote.
“Psychologically, a near 5 per cent forecast rise for 2023 may lift expectations for both business and households, particularly with wage negotiations that are currently taking place.
“Negotiations may also be influenced by further progress in the proposed changes, which the government is now close to legislating, that would allow for industry-wide bargaining.”
‘Price-wage spiral’ risk
The bad news for workers is that, even with a slight increase in the bank’s wage growth forecasts, to close to 4 per cent by the end of next year, it is now expected to take until the end of 2024 for pay packets to again grow faster than the cost of living.
The Statement on Monetary Policy was fairly explicit on the key driver of rising inflation, and it is not wages.
“After initially being predominantly driven by supply shocks, inflation is now spreading to more persistent non-discretionary items,” the RBA noted.
“This follows an apparent increase in firms’ willingness to pass on upstream cost pressures to consumers.
“The longer these domestic pressures persist and inflation stays high, the more this could lead workers to make larger wage claims, especially in a tight labour market. This could in turn be reinforced by firms’ pricing decisions to pass on higher costs.
“If this were to occur, domestic demand would likely need to slow by more than currently forecast for inflation to return to target, with implications for the path of monetary policy.”
While this is often dubbed a “wage-price spiral” in the economic literature, the RBA appears to have consciously shifted its terminology.
“Given the importance of avoiding a price–wage spiral, the board will continue to pay close attention to both the price-setting behaviour of firms and the evolution of labour costs in the period ahead,” it warned.
The Reserve Bank is also concerned that recent jumps in rent, especially in Australia’s two biggest cities, might further entrench inflation.
“The increase in housing services inflation is notable because it has substantial weight in many countries’ consumer price indices, particularly the United States, and because rental inflation tends to be more persistent than most other price pressures,” it observed.
Rent is one of the largest single categories in Australia’s Consumer Price Index (CPI).
‘Turning points’ in the economy
At the same time, the bank has slightly raised its forecasts for the unemployment rate, from 4 to 4.3 per cent by the end of 2024.
However, information from the RBA’s liaison program — which covered about 250 firms, industry bodies, government agencies and community groups over the period from August to October — indicated that things were unlikely to get dramatically worse quickly.
“There are signs that firms are starting to see turning points in a range of economic conditions,” the RBA noted.
“While retail demand remains elevated, it seems to have plateaued in real terms and sales of new homes have declined.
“Hiring intentions have eased from very high levels and wages growth is expected to pick up further in coming quarters.”
The RBA is certainly not expecting mass lay-offs, based on its discussions with businesses.
“The share of firms that intend to increase headcount over coming months declined from around 70 per cent a few months ago to around 55 per cent in October,” the bank reported.
“However, very few firms plan to reduce headcount.”
The RBA said recent hiring was starting to show up in higher wage rises, thanks in part to a much larger than usual 5.1 per cent increase in minimum wages and 4.75 per cent for workers on awards.
However, most workers are getting pay increases less than half the level of headline inflation, which recently came in at 7.3 per cent.
“Firms reported that year-ended growth in base wages had increased to be a little above 3.5 per cent, although with a wide range of outcomes across firms and industries,” the RBA observed.
“This compares with an average increase of around 3 per cent reported by firms in the three months prior.
“The increase over recent months reflects firms’ responses to strong labour demand, the award wage increases announced by the Fair Work Commission and higher inflation outcomes.”
With essential costs of living and mortgage rates continuing to surge, the RBA has slashed its expectations of household spending by around a full percentage point over the second half of 2023 and early 2024, taking close to half a percentage point off economic growth, which is heavily reliant on the consumer.
“GDP growth is expected to be 3 per cent over 2022, before slowing to 1.5 per cent over 2023 and 2024,” the RBA noted.
“The forecast slowdown reflects the combined effects of higher interest rates and lower real wages and wealth on private domestic demand, as well as the slowing global economy.”
In short, next year and the year after are likely to be a lot tougher for Australian households and businesses than a relatively benign 2022.
