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Slowing wages and rising unemployment more important for the inflation outlook
It was a busy week for economists in Australia, with the 2024-25 Federal Budget released on Tuesday 14 May. As foreshadowed in last week’s Brief, cost-of-living subsidies were a central feature of the Budget. Specifically, electricity rebates of $300 for all households, combined with an additional 10% increase in Commonwealth Rent Assistance (CRA), will put downward pressure on inflation in the short term. Treasury estimates these subsidies will reduce the headline CPI by 50bps over 2024-25. Has the government found the magic formula for reducing inflation –subsidising household bills?
In the very short term, the electricity rebates and CRA will certainly be disinflationary. However, the downward pressure on inflation is only temporary. This is because the electricity rebates only apply for one year. Moving into 2025-26, as the rebates expire and electricity prices move back to their market rates, this will add to inflation. Similarly, while the increase to CRA is permanent, not temporary, it is still a one-off reduction in the level of rents. This means it doesn’t add to inflation next year like the expiration of the electricity rebates, but it also doesn’t contribute to ongoing disinflationary forces. Of course, the government may again choose to extend the electricity rebates at the end of next financial year, and increase the CRA support, but this is becoming a costly process for creating temporary disinflation.
There has been much commentary around how the increase in disposable income (from the subsidies), if it is spent, will be inflationary. We’ve used our global macroeconomic model to simulate the impact of this expansion in spending, and the results suggest that, while it is inflationary, the magnitude is only small.
The cost of new policies contained in this Budget (abstracting from the revamped Stage 3 tax cuts which were already factored into forecasts) was around $20b over three years. Our modelling suggests this will add around half a percentage point to the level of GDP, in aggregate, over 3 years. This will add to capacity pressures in the economy, pushing prices higher. However, the magnitude of the impact on inflation is less than 0.1% pa, which is much smaller than the average economist’s forecasting error and unlikely to sway the Reserve Bank’s thinking on monetary policy.
More important for the RBA was the labour market data released by the ABS this week, including the March quarter Wage Price Index (WPI) and the monthly April labour force update.
The WPI rose by 0.8% in the March quarter, down from 1.0% in the December quarter, while annual growth slowed to 4.1% from 4.2%. The split between private and public suggests the weakness in the March quarter was concentrated in the public sector, which slowed from an annual rate of 4.3% in December to 3.8% in March. This is a sharp slowdown, but the ABS noted that some of the public sector enterprise agreements that would have normally been agreed in this quarter were actually paid earlier, in the second half of last year. This implies the annual rate of growth in public sector wages might be biased down until more normal seasonal patterns are re-established.
Regardless of statistical quirks in the data, the momentum in wages has likely peaked, and this was also evident in private sector wages, which slowed modestly from 4.2% to 4.1%. This likely represents the beginning of a trend lower, in response to below-trend GDP growth, easing capacity constraints in the economy, and inflationary pressures starting to dissipate. The wage data were slightly weaker than QIC and RBA forecasts, which predicted wage growth of 4.2% by the June quarter. The differences are at the margin in terms of magnitude and timing though, as QIC and the RBA had both forecast the slowdown in wages to start in the second half of this year.
Employment data for April showed mixed results, with employment rising by a greater than expected 38K, but the unemployment rate rising to 4.1% (market expectations 3.9%). The unemployment rate is seen as the more reliable indicator of the state of the labour market, and hence, the rise in the April unemployment rate data suggest underlying labour market weakness. Supporting this view, the NAB business survey, also released this week, suggests the labour market is deteriorating, with easing in both employment and wages.
The discrepancy between strong employment growth but rising unemployment is explained by the outsized strength in the supply of labour. What we saw in the April report was continued robust growth in the working age population estimates, which drove up growth in the labour force. So, while employment rose by 38k, the labour force rose by almost 70k, underpinned by another 57k addition to the working age population.
The growth in working age population continues to exceed our expectations. The Budget upgraded projections for total population growth in 2023-24 to 2.2% from 1.9%. But with only two months remaining in this fiscal year, annual growth in working age population is currently running at 2.9%. Such a discrepancy between working age population and total population would be unusual, suggesting that there may be further upside to the government’s forecasts. While increased population adds to supply in the economy, it is clearly creating pockets of excess demand, such as in the housing market. If labour demand slows as we expect given the weakness in the economy, but labour supply continues to hold up, the speed of adjustment in the labour market will be faster and more pronounced than we, and the RBA, expect. Faster upward pressure on the unemployment rate could have the genuine disinflationary effect the Budget hoped to achieve.