MNI INTERVIEW: Wages To Limit RBA Easing - Ex Research Chief

Trimmed-mean inflation is likely to remain near the top of the Reserve Bank of Australia’s 2-3% target if wages outpace its assumptions despite its recent productivity downgrade, the RBA’s former head of research told MNI, noting this would limit the degree of further easing. 

“I’m only expecting one more cut to 3.35%,” said John Simon, adjunct fellow at Macquarie University and head of the RBA’s economic research department from 2014 to 2024, adding this will likely occur at the November meeting. While markets have priced a 3.1% terminal rate by Q2, Simon said this is likely to be revised higher as new wage data emerges.

Simon questioned the RBA’s assumption that workers have already moderated wage expectations in line with its view that productivity growth has declined.

“[The RBA] made forecasts consistent with that lower productivity and said it doesn't change its inflation forecast, which, yes, it's technically true. I guess I don't buy that,” he said, pointing to the Reserve’s productivity growth downgrade following its most recent 25-basis-point cut to 3.6%. (See MNI RBA WATCH: Bullock Points Toward Further Cuts)

 “I find it hard to believe that they’ll adjust wage demands just because the RBA says productivity is lower,” he said, noting that workers are still catching up on real wages lost during the pandemic.

Recent enterprise bargaining agreements suggest annual wage growth around 4% over the next three years, Simon said, adding that this would be inconsistent with the Bank’s inflation target. “It's wage growth that is inconsistent with practically zero productivity growth and 2.5% inflation. Historically, it may not seem particularly high, but, given where we are, three-point-anything on wage growth is inconsistent with the inflation target being hit."

The Bank is likely to be forced to lift its market path cash rate assumption closer to 3.35% when it releases its next round of forecasts in November, he added. Simon has been a vocal critic of the RBA's productivity growth outlook, arguing for some time that it needed re-evaluation amid a tight labour market and strong wage growth. (See MNI: Weak Productivity To Cramp RBA's Easing Path - Ex Staff)

FORECASTING FIX

Simon also highlighted the opacity in the RBA’s forecasting process, noting the Bank applies downward adjustments to its models but the scale and timing of these are unclear. “Putting your finger on how much judgement is being applied and where in the process is very difficult,” he said, adding that the RBA’s smoothing of short-term base effects may further obscure the real impact of underlying inflation trends.

Even small adjustments can subtly shift the forecast in the direction the Bank wants, Simon said. The RBA should be more transparent in its forecasting, and should acknowledge probable volatility in the coming quarters and explain that short-term swings are not meaningful, he said.

Simon also questioned the interplay between forecasts and policy decisions. "The question becomes how much does the forecast influence policy? Or does policy influence the forecast? Once again, I think that's the difficulty with the current process, where they don't have essentially an independent team giving the forecast, and then they decide policy. It's very much a big ball of string where it's all tied up and it's very hard to disentangle what's going on."