Inflation has eased, so what would trigger the RBA to lift interest rates again?

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Every month millions of renters and mortgage borrowers save less, dip into their savings or go without to afford higher costs of housing.

It's tough.

The Reserve Bank has hiked interest rates 11 times over the past year, and rental increases have hit record highs across the nation.

It's all a bit mixed up: elevated inflation has put the onus on the RBA to tighten monetary policy but rental price increases, which stem in part from rising interest rates, also fuel inflation.

Indeed, the high prices of many of life's basic essentials including gas, electricity, food and rents are all proving "sticky".

It means even as what economists call "core" inflation eases, the Reserve Bank will remain like a coiled spring, ready to raise interest rates.

So, what could trigger the central bank to increase its cash rate again?

There's a downside to your pay rise

Data showing households expect inflation to remain significantly elevated (higher "inflationary expectations"), or troubling monthly inflation data could both do the trick. But stronger wages data, or evidence of growth in workers' pay packets, is the key.

Evidence of rising inflation and "larger" wage increases prompted the bank's aggressive rate-hiking cycle in the first place, back in May last year. On Wednesday, we will learn if Australian workers' pay packets are growing at a rate that could force the Reserve Bank's hand in lifting interest rates for a 12th time.

It's the release of the ABS Wage Price Index. And there's one number in that index that economists are sweating on.

It's fair to say the Reserve Bank has been focused on wages growth for many years. Its own research and commentary leading up to the first interest rate hike in May highlighted the bank's belief that for inflation to really take off, wages growth would need to lift in a material way.

When its business liaison picked up signs of "larger" increases in wages growth it pulled the trigger on tighter monetary policy. Official data that's since been released shows wages growth was not increasing in a substantial way at this point.

However the bank's anxiety around wages growth is justified given history shows that when growth in pay packets lifts, inflation follows.

Economists argue that although this was a problem in an environment of centralised wage fixing (which was in place in the 1970s), and onset of enterprise bargaining and a decentralised system of wage determination has put an end to significant growth in wages.

Still, the RBA remains eagle-eyed on wages growth.

The statement accompanying the RBA's May decision noted: "The Board remains alert to the risk that expectations of ongoing high inflation contribute to larger increases in both prices and wages, especially given the limited spare capacity in the economy and the historically low rate of unemployment."

"Accordingly, it will continue to pay close attention to both the evolution of labour costs and the price-setting behaviour of firms," RBA governor Philip Lowe said.

And just to ram the point home, in the all-important final paragraph of the statement, the governor wrote: "The Board will continue to pay close attention to developments in the global economy, trends in household spending and the outlook for inflation and the labour market."

Two reasons the labour market outlook is crucial

And the outlook for the labour market has now become crucial for two reasons.

Firstly, if the already announced RBA interest rate hikes hurt economic growth (consumer spending) as they progressively hit bank accounts over the next few months, unemployment will rise.

Both Treasury and the Reserve Bank see the unemployment rate increasing above 4 per cent into next year.

The question is whether the jobless rate will rise much higher than that and lead to a recession. This would see the RBA slashing rates next year.

Secondly, if the labour market remains tight, despite the interest rate hikes, labour costs may continue to rise and wages growth with it.

The Reserve Bank is forecasting wages growth to lift above 4 per cent this year, and then to slip back a bit by 2025.

Key to these forecasts is how effectively workers can organise themselves around collective bargaining agreements, individual agreements, and the decisions made by Fair Work.

"The upcoming Fair Work Commission (FWC) decision on the national minimum wage will be critical to the outlook for wages growth and by extension inflation and the monetary policy outlook," the CBA noted.

The CBA may be into something there, especially after news late last week of the government appointing 12 new members to the Fair Work Commission — all with union backgrounds.

Wages-price-spiral is the culprit

But here's the critical point: It's a wages-price-spiral that would push the Reserve Bank to lift interest rates higher.

A fundamental fear held by the Reserve Bank is that consumers will start to expect inflation to remain significantly elevated. Economists call this "inflationary expectations".

The RBA claims these "expectations" are well-anchored or, to put it in simple terms, that prices at the stores will eventually return to more normal levels.

If this shifts, consumers who are on the whole employed will be extra motivated to ask their boss for a substantial pay rise.

Businesses would then pass these pay rises on to customers in the form of higher prices. This would mean the "sticky" inflation we have now, due to persistently higher rental, gas electricity and food prices, would be super-charged.

The argument against this, of course, is that workers remain in a fundamentally weak wage bargaining position due to systemic constraints — one of which being the ability to effectively bargain for higher pay.

Economists anxious about the number one

The bottom line now is that wages growth, as painstakingly slow as it's been, has now risen enough that another leg-up could push it to a level, economists say, that would warrant concern by the Reserve Bank.

The National Australia Bank's chief economist Alan Oster says he thinks "a quarterly [WPI] above 1 per cent would be enough" to make the Reserve Bank nervous.

And by "nervous" he means it would pressure the bank to raise the cash rate again at time when it's obviously reluctant to do that.

"Our internal [data] however is a bit softer," he says — showing the WPI will come in at 0.8 per cent growth for an annual increase of 3.6 per cent. It's currently 3.3 per cent.

AMP's chief economist Shane Oliver support Oster's view and says a WPI above 1 per cent would make the RBA "nervous about wages".

The wealth manager is expecting the wage price index to come in at 0.9 per cent.

Commonwealth Bank economist Gareth Aird is also expecting wages increased 0.9 per cent in the March quarter.

It's awkward

So we've arrived at this really awkward moment for the economy: the ongoing tightness in the labour market, and the mild upwards pressure it's putting on wages, could push the Reserve Bank to continue on its interest rate-hiking journey.

At the same time, sticky inflation means millions of workers' real wages continue to go backwards.

The Reserve Bank governor has been warning of this moment since the rate-hiking cycle began, arguing workers needed to struggle through lower real wages growth and essentially "hold out" for inflation to return to being slightly under nominal wages growth.

The assumption then, though, was that inflation would be "transitory".

Journalist Rick Morton tweeted late last week: "Everyone is very angry!"

Yes, that's often the emotion that follows frustration.

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(Original ABC Article)