Wages also warrant close monitoring – indeed this is what drives most economic models. The rule of thumb is that wages growth needs to be running at around 3½ per cent for (underlying) inflation to be running at 2 ½ per cent.
The labour market has tightened, but wage growth is only just back to pre-pandemic levels, and at 2.2 per cent annually is consistent with low inflation.
While wage growth is accelerating in some sectors (particularly for those on individual agreements), the structure of wage setting in Australia is sticky, as many wages are renegotiated infrequently and are tied to slow moving inflation expectations. A large portion of the workforce is under Enterprise Bargaining Agreements or impacted by public sector wage freezes and caps, so tight labour markets take time to feed through.
Faster wage growth is expected to slowly feed through and lift underlying inflation to the top half of the Reserve Bank’s target band over the latter half of 2022 and early 2023. Headline inflation is forecasts to hover around three per cent.
But again, this needs to be seen in context of higher, but not worryingly high, inflation.
Australian firms should plan for higher, but not historically high, inflation and interest rates – which will require a different strategy from the past five to ten years. This strategy shouldn’t just encompass cost control, which is part of the story, but should extend to productivity enhancing investments, changes in processes and a renewed focus on innovation to make more with less.
Perhaps more importantly, given the vagaries of forecasting – particularly with the pandemic and its consequences – we should all keep a close eye on inflation expectations and wages, as that is what will provide the early signal that we are wrong, and inflation is set to accelerate rapidly.