Strong unit labour costs challenge the RBA
Strong unit labour costs risk delaying the return of inflation to the 2-3% target band
Inflation peaked last year and has fallen this year, but there is still significant uncertainty around how much time it will take for inflation to sustainably return to the RBA's 2-3% target.
One key risk revolves around unit labour costs - which are labour costs adjusted for labour productivity - continuing to grow strongly, underpinning high services inflation and making the RBA's job more difficult.
This risk comes up repeatedly in RBA commentary, most recently in this week's policy press release, where the RBA stressed that:
"Wages growth has picked up over the past year but is still consistent with the inflation target, provided that productivity growth picks up."
The risk was also brought home in today's national accounts, which showed a mix of modest economic growth and continued strong growth in unit labour costs, which CCI's analysis shows has accounted for most of the high domestic inflation over the past year or so.
Nominal unit labour costs increased by about 1½% in Q2 to be 7½% higher than a year ago, which, excluding the distortions caused by COVID-related policies, is the fastest growth since 1990, three years before the RBA adopted its 2-3% inflation target.
Hourly wages remain very volatile on a quarterly basis and are up about 3¼% over the past year (wages per employee grew more strongly at about 6% given a wedge created by employees working more hours over the past year).
However, hourly labour productivity remains in terrible shape, driving the strength in unit labour costs that poses the ongoing risk to inflation.
Labour productivity is difficult to measure, but fell again in Q2 to be down about 3½% over the past year.
Some of this weakness reflects an unwinding of the temporary boost to productivity during the pandemic, but the trend remains dismal with the level of productivity now at its lowest point since early 2016.
CCI's analysis has shown that Australia's poor productivity performance predated the pandemic and reflects firms persistently underinvesting in their workers and failing to take full advantage of global technological innovations.
Although companies have started to invest again, turning the trend around in productivity could take a long time, such that unit labour costs could continue to grow at a rate that delays the sustained return to low inflation.
The RBA no doubt realises the scale of this challenge and will likely be aiming for a cyclical improvement in productivity, where companies cut hours worked, which raises a clear risk of some eventual job losses.
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Based in Sydney, Kieran Davies is Chief Macro Strategist at Coolabah Capital Investments, an asset manager with 40 executives and over $8 billion in fixed-income strategies. Kieran is responsible for macroeconomic research and investment strategy, contributing to the investment decisions of the firm. Kieran has long experience as a macroeconomist in both the private and public sectors. He has worked most recently as Chief Markets Economist for National Australia Bank and was previously Chief Economist, Australia and New Zealand, for Barclays Bank and ABN Amro Bank/RBS. Kieran also worked as Principal Adviser on the macroeconomy and budget policy in the Commonwealth Treasury and Director of Forecasting.
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Based in Sydney, Kieran Davies is Chief Macro Strategist at Coolabah Capital Investments, an asset manager with 40 executives and over $8 billion in fixed-income strategies. Kieran is responsible for macroeconomic research and investment strategy,...
Based in Sydney, Kieran Davies is Chief Macro Strategist at Coolabah Capital Investments, an asset manager with 40 executives and over $8 billion in fixed-income strategies. Kieran is responsible for macroeconomic research and investment strategy,...
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