Wage pressures mount, interest rates to be cut

The headline unemployment rate improved to 4.2% in March, down from 4.3% in December, but still up on the 4.0% reading from last September. Scratching beneath the surface shows that employers are becoming increasingly reluctant to hire. Signs of collective agreements agreed on last year are also beginning to show up in public sector wages. These observations, coupled with a further slowing of forward-looking indicators over recent months, suggest that the Reserve Bank will cut its target interest rate (the Official Cash Rate) again in August.

When considering wages, I like to look at the adjusted LCI, which measures movements in wages for a fixed quantity and quality of labour. This approach means that I get to compare like for like and don’t get distracted by pay creep from things like promotions.

The adjusted LCI shows that public sector wage inflation ran at 2.0%pa in March, up from 1.7%pa in December. Public sector wage inflation is running at its fastest rate since June 2010.

Private sector wage inflation also recorded 2.0%pa in March, the same rate as it had been in December.

Wage inflation could pick up further across both sectors over the next couple of quarters. Key drivers will be settlement of other ongoing pay disputes, and the minimum wage increase of $1.20 to $17.70 an hour on 1 April 2019 flowing through.

These wage pressures, however, come at a risky time for the economy as activity is showing signs of slowing.

The recently released NZIER Quarterly Survey of Business Opinion (QSBO) showed that business profit margins are being squeezed, falling to their lowest level since 2011. NZIER highlighted that wage pressures may be partly to blame.

But more worryingly, the pressure on profitability is showing signs of weighing on investment and employment. The QSBO showed that reported employment turned negative for the first time since 2012. Data from the QSBO is consistent with GDP growth slipping below 2%pa.

The QSBO result will be worrying the Reserve Bank of New Zealand (RBNZ) and provides clear evidence that the economy is beginning to struggle.

To counteract the risk of a slowdown becoming entrenched, the RBNZ is likely to cut its target interest rate (the Official Cash Rate) again at its next review in August. Furthermore, unless there are significant signs of improvement to domestic economic data and a reduction of global risks, then a second cut in November to an unprecedented 1% is possible.