The Big Picture

market analysis

The Big Picture

By

Paul Ashworth, Managing Partner


Posted 03 November 21

Do fiscal & monetary policy conflicts in Australia result in higher interest rates? Border reopening suggests maybe not.

The RBA is clear in its cash rate setting objectives that it wants to see inflation within the 2% to 4% band. To that end, it views wages growth as needing to be between 3% to 3.5% however, it is currently 1.9% p.a. Despite this gap, markets are pricing rises in the cash rate in sync with expectations for the US Fed Funds rate. Currently, a 75-basis point increase is priced in by markets for early 2023. This is a convenient nexus for markets to make between the US and Australia cash rate futures curve, but that may be all it is, convenient.

The big unknown in Australia is labour supply and the extent by which relaxed borders and government policy on immigration drives labour supply. Whilst there remains debate on the extent by which immigration in Australia suppressed wages growth over the eight years prior to COVID-19, there can be little conjecture that there has been a reduction of nearly 800,000 visa holders and total employment is therefore lower than pre-COVID. Consequently, we are seeing wages cost pressure. From an RBA viewpoint, all things being equal, this wages cost pressure could be expected to build towards the RBA wages growth target. The result would support increases in the cash rate, and sooner.

In the chart below, we can see that wages growth is around 1.9%. For inflation to operate within the 2% to 3% band, wages growth needs to be between 3% to 3.5% ( the shaded box). Wages growth is still a distance away from this target.

Diagram showing

With the re-opening of international borders, State Premiers and the Federal Government face fiscal consolidation and re-build. Renewed discussion on immigration is occurring. Premier Perrottet and his government is taking a lead position on NSW being a ‘big economy’. Andrews in Victoria is equally motivated.

Immigration drives raw economic growth, addresses skills shortages in an otherwise ageing population and generates taxes – stamp duty, GST, income tax. Additionally, it provides both skilled labour and general employment – basically supply of labour.

Does this take us back to the pre-COVID economy when there was raw headline economic growth but none in per capita terms and the same for wages and underemployment? Headline immigration targets is but one measure typically put out by government, but the other 14 or so different types of temporary visas that are available need to be added. The scope for working age population increase is substantial, and one suspects probably irresistible for governments. This would see muted pressure on wages growth and arguably inflation.  Governments are broadly satisfied with higher taxation revenue and reduced pressure on interest rates, however the RBA would need to completely rethink its inflation and wages targeting policy.

The political election cycle next year will illuminate this, but the prospect of more taxpayer ‘customers’ for both the State & Federal Governments is looking pretty irresistible. If this were to occur, cash and bond market futures in Australia may be a bit premature in the speed and path for increasing cash rates.