A Balancing Act: Wage Growth and Inflation

Key takeaways:

Inflation has been outpacing wage growth, causing real wages to drop. This decrease is anticipated to continue over the coming months and weigh on consumer spending.

Supply constraints are set to continue driving up prices in the short term. The RBA is expected to further increase the cash rate as it attempts to tame inflation.

Tight labour market conditions are placing upward pressure on wages, creating more competition among businesses to attract employees.

Australians are enduring increasing cost of living pressures, with households facing higher prices for everyday expenses such as food and fuel. However, despite Australia’s high inflation rate, many other countries are experiencing more extreme price rises. Inflation increased by 1.8% in the June quarter of 2022 and rose by 6.1% over 2021-22. This growth marks the fastest rate increase since 2001, a year after the GST was introduced. In comparison, wages grew by only 2.4% over the year to March 2022. Tight labour market conditions are placing upward pressure on wages, with the unemployment rate falling to 3.5% in June 2022 and job vacancies remaining near record highs.

Although wage growth fell over 2020 due to the COVID-19 pandemic, it has now increased for five quarters in a row. However, growth in wages continues to undershoot inflation as Australians face a decline in real wages, meaning that consumer purchasing power is falling. While retail spending remains robust and many households built up a savings buffer during the COVID-19 pandemic, declining real wages are threatening retail spending, particularly for discretionary items.

A balancing act

Balancing wage growth and inflation targets can be difficult, as accelerating wage growth can create additional inflationary pressure. Businesses can usually pass a portion of wage increases on to customers as higher prices, adding to inflation. The RBA has taken steps to contain inflation, lifting the cash rate at its last three meetings from 0.10% to 1.35%. Residential housing loan rates have followed suit, and the increases have added over $450 to the average monthly mortgage repayment for new owner-occupiers. While the rising cash rate is likely to start taming inflation over the year ahead, higher interest rates are also going to hurt Australians’ hip pockets and cause house prices to fall.

Drivers of inflation

A range of factors have driven inflation in the economy in recent months, and prices typically rise faster in a growing economy. Economic activity has recovered following COVID-19 pandemic-related restrictions easing, as these have placed upward pressure on prices over the past year. Tight labour market conditions have also created inflationary pressure, and a falling unemployment rate and high number of job vacancies have encouraged businesses to increase wages to attract workers. However, supply-side factors have been a key driver of inflation over the past year. These supply-side factors include:

Supply disruptions due to the Russia-Ukraine conflict
Adverse weather events, such as flooding in New South Wales and Queensland
Ongoing global supply chain disruptions due to the COVID-19 pandemic

The Russia-Ukraine conflict has caused global energy prices to rise. Russia accounts for approximately 12% of global oil production and 17% of global natural gas production. Production and supply disruptions due to the conflict have placed upward pressure on global fuel and energy costs. While oil and gas producers and coal miners have benefited from rising commodity prices, Australian consumers and businesses are facing higher petrol prices and energy bills.

The conflict has also pushed food costs higher. Farmers have seen costs for inputs such as fertiliser and fuel rise. Furthermore, trade in agricultural commodities has also been disrupted, as Russia and Ukraine together account for almost 30% of global wheat production. Domestic wheat and coarse grain prices have risen sharply, and flooding in parts of New South Wales and Queensland throughout the year has also affected domestic food prices. These changes have disrupted domestic food production, increasing consumers’ supermarket bills and the prices of some grocery items. Ongoing global supply chain disruptions have also boosted prices over the past year.

Wages and unemployment

Tight labour market conditions have accelerated wage growth over the past year. Wages grew by 2.4% over the year to March 2022, the strongest annual growth recorded since December 2018. Competition has increased to attract employees, with net migration falling sharply during the COVID-19 pandemic and border restrictions leading to labour shortages across many industries. The national unemployment rate fell to 3.9% in the first half of 2022, the lowest rate since August 1974, while the labour force participation rate increased.

According to ABS data, job vacancies were 111.1% higher in May 2022 than in February 2020 before the COVID-19 pandemic hit, and over a quarter of businesses across the economy now report job vacancies. Most sectors of the economy have also experienced labour shortages. For example, 34.0% of businesses in the Accommodation and Food Services division reported vacancies, including restaurants, cafes and coffee shops. Meanwhile, almost a third of firms in the Construction division and quarter of businesses in the Mining division also reported vacancies.

Based on the data, the Healthcare and Social Assistance division has the highest number of job vacancies at 68,900, followed by the Accommodation and Food Services division at 51,900 vacancies. Other divisions with significant vacancies include Retail Trade (40,300) and Professional Services (42,900).

Outlook

The RBA has called for businesses to show restraint when lifting wages, in an effort to contain consumer spending and prevent further inflationary pressure. However, inflation is still expected to rise further over the coming months, as high input prices continue to pass through supply chains. In particular, manufacturers, construction companies and agricultural businesses are expected to face continued cost pressures. These businesses may need to identify areas where costs can be cut and benefit from identifying potential supply chain weaknesses.

Further increases in the cash rate are anticipated over the year, as the RBA seeks to bring inflation back towards its target band of 2-3%. Tight labour market conditions and record highs in job vacancies are also expected to continue to boost wage growth over the coming year, as the unemployment rate falls further and businesses compete to attract employees. Businesses across the economy may need to offer additional incentives, such as flexible working conditions and benefits, in addition to competitive salaries to attract employees. Some firms may also be able to automate some functions through investing in technology. However, wage growth is expected to continue lagging behind inflation over the year, decreasing real wages. This trend and rising interest rates are anticipated to create additional cost of living pressures for consumers.

IBISWorld reports used to develop this release:

Australian industry reports

Business Environment Profiles – Australia