Economic Weekly: Wage inflation is set to rise

The NZ labour market is back in the spotlight this week, with StatsNZ releasing the Q2 labour market statistics on Wednesday morning (see our preview here).  Over the past 6 months, the labour market has tightened significantly as the NZ economy has continued to grow, but with labour supply constrained by international border restrictions.  Following the release of the NZIER Quarterly Survey of Business Opinion, the strength of the labour market recovery no longer looks to be in doubt.  We expect the Q2 labour market data to confirm this strength.  We expect to see the unemployment rate to fall to 4.4%, from 4.7%, with further declines to come over the year ahead.

From the RBNZ’s perspective, it will be looking for confirmation the labour market is at, or very close to, maximum sustainable employment.  This should clear the path for the RBNZ to start returning the Official Cash Rate to pre-COVID levels, and we expect the first move to be later this month.  To assess maximum sustainable employment, the RBNZ looks at a range of measures beyond the headline unemployment rate.  Of particular focus will be the labour market underutilisation rate, which has shown limited improvement thus far.  This is due to the high number of underemployed actively looking for additional hours.  In addition, the unemployment rate of 20–24-year-old has also been heavily impacted by COVID-19 and, as of Q1, yet to see material improvement.

The key consequence of the tightening labour market will be the inflationary pressure it generates.  Wage inflation tends to result in more persistent inflation forces within the economy.  The higher cost of goods over the past year, due to COVID-19 related production shortages and shipping delays, are much easier for firms to pass on if workers are also receiving solid income growth to offset the higher cost of living.  We expect to see the first material increase in wage growth over Q2 – with annual LCI wage inflation lifting to 2.1%.  And we expect wage inflation to continue to build over the coming year – rising to around 3% by the end of the year. 

The RBNZ will want to get in front of this potential wage/price spiral and get the OCR off emergency settings sooner rather than later.  The economy is at capacity (though capacity is lower than what it would otherwise have been if it wasn’t for COVID-19) and inflation pressures are set to build rapidly over the coming year.  The lessons from the 2004-2007 tightening cycle is that if inflation pressures get ahead of the central bank, then it ends up lifting interest rates by even more than would have been the case if it had acted sooner.  Much like our lesson from containing COVID-19 infections, a hard and early approach can prevent a longer, more painful lockdown later on.

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Mark Smith

Senior Economist

Mark joined ASB in 2017, with over 20 years of public and private sector experience working as an economist in New Zealand and the UK.

His resume includes lengthy stints at ANZ and the Reserve Bank of New Zealand, and he has also worked at the Bank of England, HM Treasury and the New Zealand Transport Agency. Mark's areas of specialisation include interest rate strategy, macro-economic analysis and urban economics.

Born and bred in the Waikato, Mark studied at Waikato University where he graduated with a Master of Social Sciences, majoring in Economics.

Mark's key strengths are the ability to use his extensive experience, inquisitive nature, analytical ability, creativity and pragmatism to dig a little deeper and to deliver common sense solutions to tackle complex problems.

When not at work Mark likes to travel, keep fit and spend time with his friends and family.