RBA and wages: We have seen the lows – TDS

The impact of yesterday’s RBA 4 July Board meeting Minutes is still reverberating and analysts at TDS remain of the view that there has been a subtle shift in the Bank’s signalling, while many still see the market reaction as somewhat overdone.

Key Quotes

“A line in the Minutes referring to wages has caught our attention:

• 4 July Board statement: “Wage growth remains low, however, and this is likely to continue for a while yet”. As this has been repeated every month this year, it has next to no impact on market thinking. However:
• 4 July Board Minutes: “Members noted that the strength of recent labour market data had removed some of the downside risk in the Bank’s forecast of wage growth”. Where did this come from?”

“The RBA regularly comments on the strength or otherwise of employment growth, but always concludes that wages are subdued and expected to remain low. We expect tomorrow’s labour force report to show that employment remains strong.”

“Nearly all industries have added jobs, particularly Health, Education and Construction. Within the Wage Cost Index (WCI) we pulled out the cyclical sectors (manufacturing, construction and private professionals) and compared with wages growth in the services sectors (Food/accommodation, retail, health and education). By Q1, cyclical wages growth had bounced, while services wage inflation continued to decelerate. The Q2 update is released on 16 August, and we’ll be looking for further improvement in cyclical wages growth.”

“The RBA minutes highlighted the Fair Work Commission’s decision on minimum wages, whereby “The (FWC) announced a 3.3% increase in award wages and the national minimum wage, effective from 1 July 2017 …. affect[ing] around 2/5 of workers”. We found a compelling correlation between TD’s services sector WCI and minimum wage growth. Aside from the zero to 4.8%/yr distortion during the GFC, minimum wage decisions are the key driver of services wage growth. The recent 3.3%/yr rise in minimum wage growth—the strongest since Sep 2011—implies that by Q3 2017, services sector WCI could rebound at least 2.5% if not 3%/yr.”

“And for the RBA?

We see the next two WCI reports not only putting an end to ‘record low wage growth’ headlines, but expect wage inflation to pick up towards 2½%/yr by Q3 (released mid-Nov). Waiting for these reports adds to our case for RBA patience, despite this week’s shift in tone. If we are right about the employment report tomorrow, we see yesterday’s market moves as the beginning of rising market anticipation for higher RBA cash rates. While February 2018 is possible, our base case will remain for a May 2018 hike unless wages and CPI materially surprise to the upside in the interim.”