AUD: Watching wages - Rabobank

For many developed economies, the most important data release at present refers to wage inflation and in Australia the key Q4 wage price index is due for release tomorrow, points out Jane Foley, FX Strategist at Rabobank.

Key Quotes

“Several major central banks, including the Fed and the BoE, are assuming that an increase in CPI inflation will be driven higher by an increase in demand which will be fed by stronger wage growth.  Higher earnings are expected to result from the tight labour market conditions that are prevalent in many major economies at present.  A similar dynamic is expected in Australia, though the RBA’s assumptions on domestic wage growth are arguably more cautious than those of its US and UK counterparts.”

“The reason for this is that Australia has been suffered an extended period of extraordinarily weak wage inflation.  The minutes of the RBA’s February policy state that “members noted that the Bank's forecast for a modest rise in growth in consumption was predicated on a pick-up in household income growth. There was still a risk that growth in consumption might turn out to be weaker than forecast if household income growth were to increase by less than expected”.”

“Economists throughout the developed world have been scratching their heads during the past few years over why tight labour market conditions are failing to generate much wage inflation. A lack of trade unions power, the replacement or skilled or semi-skilled manufacturing jobs with low-skilled, low paid employment and demographic changes may be some of the contributing forces.  For several countries, including Australia, the environment of high household indebtedness may also be playing a part in hindering the traditional pass-through between household income and stronger consumer demand.  According to the RBA’s February minutes “in an environment of high household indebtedness, consumption might be particularly sensitive to adverse developments in household income or wealth”.”

“A recent speech by Norges Bank Chief Olsen in which he referred to smaller economies being forced to import low interest rates from recession hit larger economies during the financial crisis in order to maintain exchange rate stability. In turn these low interest rates fuelled house price appreciation and high levels of household debt which have subsequently have had to be controlled by macro-prudential measures.  In this respect there are clear analogies between countries such as Norway, Australia and Canada.”

“Central banks of countries where there are high levels of household debt are presented with the dilemma of needing to normalise policy on one hand (in part to deter a further build-up of household debt) while fearing that any move may have an accentuated impact on household spending.  The market is carefully watching how impact of the recent three BoC rate hikes plays out on the consumer sector in Canada.  Last week BoC Deputy Governor Schembri indicated that policymakers are looking closely at how high levels of debt could pose a challenge to monetary policy.  Other central banks are also likely to be watching the impact in Canada also.”

“At the RBA, the tone remains cautious. The February minutes recognise that “growth in consumption had continued at a relatively modest pace, constrained by low household income growth despite stronger-than-expected employment growth and a decline in the unemployment rate over 2017”. The minutes also pointed out that “even with the strength in the labour market, wage growth was yet to pick up”.   Overall, the RBA is of the opinion that “the increase in inflation was likely to occur only gradually as the economy strengthened”.  This reaffirms the risk that steady policy is likely to persist through 2018. We expect that interest rate differentials will allow AUID/USD to end the year moderately lower this year around the 0.75 level.  However, for the time being the AUD/USD is continuing to draw support when risk appetite is elevated.”