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A wages boom is unfolding - should we prep for an interest rate hike in 2022?

·5-min read
Is an interest rate hike coming next year? Source: Getty
Is an interest rate hike coming next year? Source: Getty

It's good news for the economy - Australia is entering a period of accelerating wages growth.

For the first time in about a decade, widespread skills shortages, unexpected economic strength, no immigration and a rampant surge in household wealth are unleashing a reversal in wage oppression that has dogged the economy for so long.

Every now and then, things unfold that make every economist take stock of their assessment of economic conditions, the pressures within policy settings and how the business sector is behaving.

The onset of the COVID-19 pandemic a little over a year was one such, blindingly obvious, event.

For me, a change has emerged in the last month or so to make me look at the low wage/low inflation picture through a different lens.

Listening to business

That change follows a hectic schedule of client meetings that have had one over-arching line of discussion and feedback - wages.

Common themes include:

  • “I can’t find the workers I need to expand my business.”

  • “I am having to offer higher pay to attract talent.”

  • “I need to start thinking about incentives to retain my existing experienced staff before they are lured away by a competitor – I have to pay them more”.

This means one thing - private sector wages growth is about to take off.

The trajectory of those wage rises is difficult to pin point, but within the next few quarters, don’t be surprised to see annual private sector wages growth easily exceeding 2.5 per cent and be squarely on its way to 3 per cent and more.

In the pre-COVID environment, many firms would look overseas for workers and talent. In 2021, this is no longer a source of labour for them. International borders are closed.

Indeed, it is clear that one effect of the COVID pandemic and the associated border closures is to allow for stronger wages growth.

With the economic recovery continuing to unfold, firms are looking to ramp up their investment, and with it, they are looking for more staff. Some semi-skilled, some are highly skilled.

Businesses and labour hire companies are screaming about a lack of workers on their books. All of the various measures of job vacancies and job advertisements are booming. The number of job vacancies is well above pre-COVID-19 levels, a time when the unemployment rate was a tick or two above 5 per cent.

As this demand for labour translates to actual new jobs in the months ahead, it is likely the unemployment will drop well below 5 per cent and with that, wage pressures will intensify.

Unfortunately, the public sector will hold back the wages recovery.

The Commonwealth and most State and Territory governments have either imposed wage freezes or limited increases to 0.5 to 1.5 per cent for most of their employees. This wage austerity needs to end soon, so that public sector wages are not level behind the private sector rises.

Wage freezes or tiny increases are poor policy choices as the economy emerges from recession. It risks seeing staff flee the public service and move to the private sector, and also will limit the good news from wages increases elsewhere in the economy.

Inflation will lift, but what about interest rates?

The link between wages and inflation is clear. The looming lift in wages will feed into inflation pressures as firms work to cover their rising labour costs with higher selling prices. As wages growth accelerates, so too will inflation.

This is in fact one of the goals of the RBA with its cash and 3 year bond targets at 0.1 per cent.

There are significant implications for interest rates in this climate.

It wont be long before serious talk of hikes in official interest rates emerges.

If wages growth lifts towards or above 3 per cent in 2022 on the back of the unemployment rate falling through 5 per cent, a 0.1 per cent cash rate would be inappropriate. Indeed, there will be a hot debate about exactly when and by how much interest rates will need to rise.

It is not fanciful to think interest rates will be 2 percentage points and higher during 2023.

This will have implications for the refinancing of government debt, which in next week’s budget will be forecast to hit $1 trillion. If wages and then inflation rise, government bond yields will surge. It wasn’t that long ago that 10 year government bond yields were 4 per cent.

Already, some of the smart investors have been positioning for this sea-change in inflation.

The Australian 10 year government bond yield, which fell to just 0.85 per cent in 2020 as the COVID-19 recession unfolded has lifted to around 1.75 per cent today.

Markets are also pricing, at the margin, the chance of a hike in official interest rates before the 2024 timeframe outlined by the RBA.

This is just the start of what is set to be a material rise in government bond yields and it will a recast of the economic environment for the next few years.

All of these changes will not happen overnight but a rise in wages will be evident within the 12 months. If the anecdotes are accurate, the acceleration in wages will be significant which will feed through to a sustained lift in inflation and with that, interest rates.

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