AUSTRALIAN MARKETS WEEKLY

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1 5 March 19 AUSTRALIAN MARKETS WEEKLY A higher minimum wage is unlikely to jolt overall wages out of their low-growth rut In this issue A higher minimum wage is unlikely to jolt overall wages out of their low-growth rut Calendar of economic releases Forecasts 7 To contact NAB s market experts, please click on one of the following links: Ask the Economists Ask the FX Strategists Ask the Interest Rate Strategists In this weekly, we have looked at low inflation, focusing on the role played by weak wage growth. Underlying inflation has remained persistently low, undershooting the RBA s target band for three years now given sluggish growth in average earnings and low inflation expectations. The ALP has signalled it will amend the legislation governing the Fair Work Commission in order to lift the minimum wage. We do not think that a larger-thannormal increase in the minimum wage would have a major effect on average earnings unless the minimum wage was quickly redesigned as a living wage aimed at lifting low-paid workers out of poverty. This leaves addressing spare capacity in the labour market as the main catalyst for boosting wages growth. Unemployment has fallen to an eight-year low of.9%, but there is still spare capacity given the RBA has reduced its estimate of the NAIRU to close to.5%. At the same time, labour mobility remains at a historic low, where increased job switching typically foreshadows faster wage growth. Low wage growth and low inflation suggest that the RBA can afford to provide more stimulus to the economy, especially as concerns over house price inflation and rapid growth in household debt have eased. We continue to forecast the RBA will cut the cash rate from 1.5% to 1% by November 19. Developments in overseas economies support this view, even though unemployment printed at a new cycle low of.9% in February. As for this week s calendar, RBA Assistant Governor (Economic) Ellis speaks at a housing conference on Tuesday. We will be watching to see if she signals that the RBA is revising its outlook for residential construction, where the RBA s current forecast profile appears overly optimistic given the sharp fall in work done at the end of 1 and the steep decline in the leading indicators of activity. NAB forecasts an 1% decline in residential investment over the next two years, while the RBA is looking for a % fall. Further out, there have been ongoing press reports that the April Budget will offer more income tax cuts and cash hand-outs for low-income households. These are seen as providing a boost to household incomes given slow wages growth. Offshore this week, the Brexit saga is still playing out, while the beginning of an inversion of the US yield curve suggests markets are concerned about an increased risk of US recession. Several Fed officials are speaking this week. Closer to home, we expect the RBNZ to maintain a balanced policy outlook on Wednesday while keeping its cash rate at 1.75%. Key markets over the past week Last % chg week Last bp/% chg week AUD RBA cash 1.5 AUD/CNY y swap AUD/JPY ASX,11-1. AUD/EUR. -.1 Iron ore -3. AUD/NZD WTI oil Source: Bloomberg Chart of the week: The minimum wage is close to the ACTU s target of % of the median full-time wage Minimum wage as a % of the median wage of full-time workers Minimum wage relative to the median wage of full-time workers Range of other advanced economies % threshold Australia Median of other advanced economies Source: OECD, National Australia Bank Kieran Davies, Economics, Markets National Australia Bank Limited ABN AFSL and Australian Credit Licence 3 1

2 Australian Markets Weekly 5 March 19 A higher minimum wage is unlikely to jolt overall wages out of their low-growth rut Inflation has remained persistently low, undershooting the RBA s target band for three years now given sluggish growth in average earnings and low inflation expectations. The ALP has signalled it will amend the legislation governing the Fair Work Commission in order to lift the minimum wage. We do not think that a larger-than-normal increase in the minimum wage would have a major effect on average earnings unless the minimum wage was quickly redesigned as a living wage aimed at lifting low-paid workers out of poverty. This leaves spare capacity in the labour market as the main catalyst for boosting wages growth. Unemployment has fallen to an eight-year low of.9%, but there is still spare capacity given the RBA has reduced its estimate of the NAIRU to close to.5% (albeit still with a large confidence interval). At the same time, labour mobility remains at a historic low, where increased job switching typically foreshadows faster wage growth. Low wage growth and low inflation suggest that the RBA can afford to provide more stimulus to the economy, especially as concerns over financial stability have eased. We continue to forecast the RBA will cut the cash rate from 1.5% to 1% by November 19. Inflation has persistently undershot the RBA s inflation target Persistently low inflation has been a key frustration for the Reserve Bank over recent years. This is despite the bank maintaining a flexible inflation target of -3%, where it can tolerate divergences as long as inflation is still expected to return to the band over its forecast horizon. The problem is that the current divergence from the target band is the longest since the bank adopted an inflation target in Using the trimmed mean CPI as a proxy for underlying inflation, inflation has already undershot the -3% band for three years and the bank does not forecast a return to the band until late 19. This compares with the late 199s, when inflation undershot the band for roughly two years, and the Chart 1: Underlying inflation continues to undershoot the Reserve Bank s -3% inflation target % change on a year ago Trimmed mean CPI RBA inflation target Source: Reserve Bank of Australia, National Australia Bank late s, when inflation overshot the target for almost three years. Weak inflation reflects ongoing weakness in wages and low expected inflation The Reserve Bank often models inflation using a mark-up model, where consumer prices reflect: Nominal unit labour costs, which are wages adjusted for labour productivity; Import prices; and Inflation expectations. Inflation expectations are usually measured by the -year breakeven inflation rate from the bond market. A measure of spare capacity is sometimes included in this type of model. In this framework, low inflation mainly reflects the weakness in nominal unit labour costs. Unit labour costs have picked up over the past year, but annual growth of 1.3% is well below the average 3.5% rate seen in the years prior to the global financial crisis. Lower inflation expectations have also played an important role, where -year inflation expectations have fallen sharply and have been either at or below the bottom of the target band for just over three years. Expected inflation is currently 1.5%, which matches the low briefly reached during the global financial crisis and is the lowest breakeven inflation rate since inflation-indexed bonds were first issued in 195 (and the lowest since the Reserve Bank started targeting inflation in 1993). Chart : Nominal unit labour costs are weak % change on a year ago Recession Global financial crisis Source: Reserve Bank of Australia, Melbourne Institute, National Australia Bank Chart 3: inflation expectations are well below the RBA s -3% target band % Non-farm nominal unit labour costs -year breakeven inflation rate RBA inflation target Note: The Q1 19 reading is as at March. Source: Reserve Bank of Australia, National Australia Bank NAB Markets Research

3 Australian Markets Weekly 5 March 19 Weak unit labour costs reflects ongoing weakness in wages Putting aside the influence of falling inflation expectations, the weakness in nominal unit labour costs is not surprising given wages have been stuck in a low-growth rut for several years. The broadest measure of wages, which is non-farm average earnings per hour, actually stalled over 1-17 for the first time since the early 199s recession. This series is currently growing at an annual rate of.%, but this is much lower than the.5% growth averaged in the lead-up to the global financial crisis. Chart : Wage growth has picked up, but is still sluggish % change on a year ago Non-farm average earnings per hour Recession Global financial crisis Source: Reserve Bank of Australia, Melbourne Institute, National Australia Bank The ALP has signalled it will boost the minimum wage if it wins the election and has discussed a living wage Notwithstanding the recent weakness in average earnings, there is some speculation among investors that labour costs could be boosted by a higher minimum wage if the Labor Party wins the next federal election. The minimum wage serves as a safety net for low-paid workers and is set annually by the Fair Work Commission. This independent body takes submissions from employers, employees, the government and the public and determines the minimum wage with reference to a broad range of legislated criteria, namely: 1. the performance and competitiveness of the national economy, including productivity, business competitiveness and viability, inflation and employment growth;. promoting social inclusion via increased workforce participation; 3. relative living standards and the needs of the low-paid;. the principle of equal remuneration for work of equal or comparable value; and 5. providing a comprehensive range of fair minimum wages to junior employees, trainees, and employees with a disability. The Labor Party has argued that the current minimum wage of $1.93 per hour or $37.k per annum for a full-time worker was neither fair nor sustainable, adding that the minimum wage should act as a living wage, which is a socially acceptable wage designed to keep low-paid workers out of poverty.f1 1 See the Hon. Bill Shorten MP, Leader of the Opposition, Transcript of doorstop interview, 1 March 19. Labor has indicated that it would initially amend the legislation governing the Fair Work Commission to give more weight to the needs of low-paid workers, although it did not set out a numerical objective for a living wage. The union movement has pushed for a living wage equal to % of median full-time earnings The Labor Party has said that it will provide more details on its views on a living wage prior to the federal election. In the meantime, we have used the Australian Council of Trade Unions s (ACTU) target for a living wage as an upper bound for what the Labor Party might adopt. The ACTU has argued that the minimum wage should be set at % of median full-time earnings for all workers, reaching that target by boosting the minimum wage by a total of 11.5% over 19 and.1f The minimum wage last matched the ACTU s % target in 1999 and was 55% in 1, up from a low of 5% in. Compared with other advanced economies, Australia s minimum wage is high relative to the median wage, with the median ratio for other advanced economies currently %. Chart 5: The minimum wage is close to the ACTU s target of % of the median full-time wage Minimum wage as a % of the median wage of full-time workers Minimum wage relative to the median wage of full-time workers Median of other advanced economies Note: The other advanced economies are Belgium, Canada, Czech Republic, Estonia, France, Germany, Greece, Ireland, Israel, Japan, Korea, Latvia, Lithuania, Luxembourg, Netherlands, New Zealand, Portugal, Slovak Republic, Slovenia, Spain, United Kingdom, and the United States. Source: Organisation for Economic Co-operation and Development, National Australia Bank The minimum wage has outpaced average earnings over recent years, but the Fair Work Commission thinks a living wage could affect low-paid employment For its part, the Fair Work Commission has raised the minimum wage at a faster rate than growth in average earnings since late 1. Moreover, the 3.5% increase in the minimum wage in 1 was the largest increase in the series since. The commission has also considered arguments to change the minimum wage from a safety net to a living wage, but rejected them because of the likely effect on employment for people who are already marginalised in the labour market.f3 See Australian Council of Trade Unions, Submission to the Annual Wage Review 1-19, 15 March The commission said that increasing the minimum wage by enough to immediately lift all full-time workers out of poverty is likely to run a substantial risk of adverse employment effects, impacting those groups who are already marginalised in the labour market, with a corresponding impact on the vulnerability of households to poverty due to loss of employment or hours. See Fair Work Commission, Decision: Annual Wage Review 17-1, 1 June Range of other advanced economies % threshold Australia NAB Markets Research 3

4 Australian Markets Weekly 5 March 19 Chart : The minimum wage has grown at a faster rate than average earnings over recent years % change on a year ago Recession Minimum wage Source: Bray, Fair Work Commission, RBA, Melbourne Institute, National Australia Bank A larger-than-usual minimum wage increase is unlikely to have a major effect on national wages Timing wise, the federal election is widely expected on either 11 or 1 May, with the government expected to call the election shortly after the release of the budget on April. Opinion polls continue to point to the Labor Party winning the election, such that its plan to amend the legislation governing the Fair Work Commission would likely shape next year s review of the minimum wage (this year s wage decision will likely be announced in early June given the commission is holding final consultations in mid May). Our view is that a larger-than-usual increase in the minimum wage is unlikely to have a major effect on average earnings. This is because the minimum wage applies to only a small share of the work force. In 1, about. million workers (c1% of total employment) had their minimum pay rates and conditions of employment set by an award. However, only a proportion of these workers were paid the national minimum wage, with the Department of Jobs and Small Business putting the figure at. million workers (or less than % of total employment).3f This view is reinforced by analysis published by the Australian Bureau of Statistics, where the bureau estimates that award wages which encompass the minimum wage had made only a small contribution to the wage price index over recent years.f5 In 1, award wages added.pp to.% growth in the wage price index. In 17, award wages contributed.pp to a.% increase in the wage price index. A materially larger increase designed to lift workers out of poverty would be a different matter, but we think that the Labor Party would be mindful of the consequences for low-paid employment if it reshapes the Fair Work Commission. We also think that the Labor Party would take into account that unlike many other advanced See Australian Government, Australian Government submission to the Fair Work Commission Annual Wage Review 19, 15 March See Dick Page, Wage-setting methods and wage growth in Australia, 7 August 1. Wage measures Global financial crisis Non-farm average earnings per hr economies the minimum wage is relatively close to the ACTU s % objective. Labour would also factor in the ability of the tax and transfer system to provide additional targeted assistance to low-income households. Unemployment has fallen, but the RBA has lowered its estimate of the NAIRU to close to.5% With an increase in the minimum wage unlikely to have more than a modest effect on average earnings, we think that the more important catalyst for higher wages remains a tighter labour market. On that score, unemployment has fallen to.9%, which is the lowest level since 11, while the underutilisation rate, which includes workers who are underemployed, has fallen to 13.%, which is its lowest level since 13. Chart 7: Unemployment and underutilisation are at their lowest levels since the early s % of labour force Unemployment and underutilisation 5 15 Global financial crisis Unemployed Unemployed plus underemployed Source: Australian Bureau of Statistics, National Australia Bank Increasingly, we think that unemployment is unlikely to stay this low given that GDP growth slowed sharply in the second half of 1 and with the NAB business survey indicating that the slowdown has continued in early 19. At the same time, there is still likely spare capacity at the current low level of unemployment, with the Reserve Bank recently reducing its estimate of the non-accelerating inflation rate of unemployment (NAIRU) from 5% to close to.5%. That is, Governor Lowe recently testified that the bank previously thought the NAIRU was around 5%, but that now Australia could have an unemployment rate close to.5% without wage growth causing problems for inflation (albeit still with a large confidence interval).5f Labour mobility is historically low even as unemployment has fallen The NAIRU is very difficult to estimate, but other indicators suggest that there is still spare capacity in the labour market. In particular, labour mobility, as measured by the number of workers changing job, has remained low even as unemployment has fallen. Labour mobility is important given that research shows people who change employers typically secure larger pay increases than workers who remain with the same See Official Committee Hansard of the House of Representatives Standing Committee on Economics, Reserve Bank of Australia annual report 1, February 19.. NAB Markets Research

5 Australian Markets Weekly 5 March 19 company (job switchers are typically paid less than people who stay with their employer). Annual data show that.1% of workers changed their job in the past 1 months in 1, up from a multi-decade low of 7.7% in 17, but with this ratio hovering around the % mark since 15. This compares with the pre-global financial crisis experience, when 11-1% of workers had switched jobs. Chart : Labour mobility is historically low Workers who have changed job in the past year as a % of total employment Labour market mobility Global financial crisis Recession Note: We have interpolated between the annual estimates of the number of employees who have changed job to account for missing observations. Source: Australian Bureau of Statistics, National Australia Bank Ongoing low inflation provides scope for the RBA to cut rates With the spare capacity in the labour market likely to increase given the slowdown in the economy, this suggests that wage growth is likely to remain sluggish, such that inflation will remain low, particularly given the significant step down in inflation expectations. Talk of a larger-than-normal rise in the minimum wage is unlikely to change this outlook, although we would have to reassess our view if the minimum wage was quickly redesigned as a living wage. Low wage growth and low inflation suggest that the Reserve Bank can provide more stimulus to the economy, especially now that concerns over financial stability have eased, and we continue to expect the bank to cut the cash rate to 1% by November. kieran.davies@nab.com.au NAB Markets Research 5

6 Australian Markets Weekly 5 March 19 CALENDAR OF ECONOMIC RELEASES Country Economic Indicator Period Forecast Consensus Actual Previous GMT AEDT Monday, 5 March 19 US Fed's Evans Speaks on a Panel in Hong Kong US Fed's Evans Gives Speech in Hong Kong JN BOJ Harada makes a speech at conference held by DIR GE IFO Current Assessment Mar US Fed's Harker Speaks in London on Economic Outlook. 1. US Chicago Fed Nat Activity Index Feb US Dallas Fed Manf. Activity Mar Tuesday, March 19 AU RBA's Ellis gives speech in Sydney NZ Trade Balance NZD Feb -$3m JN BOJ Summary of Opinions US Fed's Rosengren Speaks at Finance Conference in Hong Kong GE GfK Consumer Confidence Apr US Fed's Evans Takes Part in a Moderated Q&A in Hong Kong UK BOE's Broadbent Speak on Statistics in London 11.. US Fed's Harker Speaks in Frankfurt on Economic Outlook US Building Permits Feb US Richmond Fed Manufact. Index Mar US Conf. Board Consumer Confidence Mar US Fed's Daly to Discuss Managing Inflation in Current Climate 19.. Wednesday, 7 March 19 GE Retail Sales MoM / YoY Feb -1/. 3.3/. 7 Mar to 3 Apr AU RBA's Kent takes part in Sydney panel 3.. NZ RBNZ Official Cash Rate 7 Mar EC ECB's Nowotny Speaks in Vienna. 19. EC ECB President Mario Draghi Speaks in Frankfurt. 19. EC ECB Chief Economist Praet Speaks in Frankfurt EC ECB's Lautenschlaeger Participates in Panel in Vienna. 1. EC ECB Vice President de Guindos Speaks in Frankfurt US MBA Mortgage Applications Mar US Trade Balance Jan EC ECB Executive Board member Mersch Speaks in Frankfurt EC ECB's Villeroy de Galhau Speaks in Geneva Thursday, March 19 NZ N.Z. Government -Month Financial Statements 1.. US Fed's George Speaks to Money Marketeers of New York NZ ANZ Business Confidence Mar AU Job vacancies Feb GE CPI Saxony MoM / YoY Mar /.3/ EC M3 Money Supply YoY Feb EC ECB's Guindos Speaks in Frankfurt EC Consumer Confidence Mar F US Fed's Quarles Speaks at ECB Conference in Frankfurt US GDP Annualized QoQ Q T US Initial Jobless Claims 3 Mar UK Nationwide House Px NSA YoY Mar.. GE CPI YoY Mar P US Fed's Clarida Speaks at Bank of France Conference in Paris US Fed's Williams Visits Puerto Rico Friday, 9 March 19 NZ ANZ Consumer Confidence Index Mar NZ Building consents Feb US Fed's Bullard Speaks at Madison, Wisconsin 1.. NZ Building Permits MoM Feb JN Jobless Rate Feb JN Tokyo CPI YoY Mar JN Industrial Production MoM / YoY Feb P 1.3/ / JN Retail Trade YoY Feb AU Private Sector Credit MoM / YoY Feb./../../ JN Vehicle Production YoY Jan JN Housing Starts YoY Feb GE Unemployment Claims Rate SA Mar UK GDP QoQ / YoY Q F./1.3./ EC ECB Executive Board member Coeure Speaks in Paris EC CPI Core YoY Mar A EC CPI Estimate YoY Mar CA Industrial Product Price MoM Feb CA GDP MoM / YoY Jan.1/ / US PCE Core YoY Jan US Chicago Purchasing Manager Mar US New Home Sales Feb US U. of Mich. Sentiment Mar F US Fed s Quarles Speaks in New York Upcoming Central Bank Interest Rate Announcements New Zealand, RBNZ 7-Mar 1.75% 1.75% 1.75% Australia, RBA -Apr 1.5% 1.5% 1.5% Europe, ECB -Apr -.% -.% -.% Canada, BoC -Apr 1.75% 1.75% 1.75% Japan, BoJ 5-Apr -.1% -.1% -.1% US, Federal Reserve 1-May.5-.5%.5-.5%.5-.5% UK, BOE -May.75%.75%.75% GMT: Greenwich Mean Time; AEDT: Australian Eastern Daylight Savings Time NAB Markets Research

7 Australian Markets Weekly 5 March 19 FORECASTS Economic Forecasts Annual % change Quarterly % change Australia Forecasts 1 19 Q1 Q Q3 Q Q1 Q Q3 Q Q1 Q Q3 Q Q1 Q Q3 Q Household Consumption Underlying Business Investment Residential Construction Underlying Public Spending Exports Imports Net Exports (a) Inventories (a) Domestic Demand - qtr% Dom Demand - ann % Real GDP - % q/q Real GDP - % y/y CPI headline - qtr % CPI headline - ann % CPI underlying - qtr % CPI underlying - ann % Wages (Pvte WPI - qtr % Wages (Pvte WPI - ann %) Unemployment Rate (%) Terms of trade G&S trade balance, $Abn % of GDP Current Account (% GDP) Source: NAB Group Economics; (a) Contributions to GDP growth Exchange Rate Forecasts Global GDP 5-Mar Mar-19 Jun-19 Sep-19 Dec-19 Dec year Majors Australia AUD/USD US NZD/USD Eurozone USD/JPY UK EUR/USD Japan GBP/USD China USD/CHF India USD/CAD New Zealand USD/CNY World MTP Top Australian Cross Rates AUD/NZD Commodity prices ($US) AUD/JPY Mar Mar-19 Jun-19 Sep-19 Dec-19 AUD/EUR Brent oil AUD/GBP Gold AUD/CNY Iron ore AUD/CAD Hard coking coal AUD/CHF Thermal coal Copper Interest Rate Forecasts Aust LNG (*) Australia Rates 5-Mar Mar-19 Jun-19 Sep-19 Dec-19 (*) Implied Australian LNG export prices. RBA Cash rate month bill rate Year Swap Rate Year Swap Rate Offshore Policy Rates US Fed funds ECB deposit rate BoE repo rate BoJ excess reserves rate RBNZ OCR China 1yr lending rate China Reserve Ratio year Benchmark Bond Yields Australia United States New Zealand Sources: NAB Global Markets Research; Bloomberg; ABS Yr Avge NAB Markets Research 7

8 Australian Markets Weekly 5 March 19 CONTACT DETAILS Market Economics David de Garis Director, Economics david.degaris@nab.com.au Kieran Davies Director, Economics kieran.davies@nab.com.au Kaixin Owyong Economist, Markets kaixin.owyong@nab.com.au Markets Research Ivan Colhoun Chief Economist, Markets and Global Head of Research ivan.colhoun@nab.com.au Group Economics Alan Oster Chief Economist alan_oster@national.com.au Important Notice This document has been prepared by National Australia Bank Limited ABN AFSL 3 ("NAB"). Any advice contained in this document has been prepared without taking into account your objectives, financial situation or needs. Before acting on any advice in this document, NAB recommends that you consider whether the advice is appropriate for your circumstances. NAB recommends that you obtain and consider the relevant Product Disclosure Statement or other disclosure document, before making any decision about a product including whether to acquire or to continue to hold it. Please click here to view our disclaimer and terms of use. NAB Markets Research