Cost-of-living pressures 'about to ease' but one 'potential spanner in the works'

Some good news on the economy is unfolding. For consumers and wage earners, it is the long-awaited, long-overdue easing in cost-of-living pressures.

By the end of 2023 and during the first half of 2024, a scenario where wages growth exceeds the rate of inflation will be in place. It probably won’t be a huge boost to real wages, but it will be a turning point for the better.

Also by the Kouk:

• Why Australia's house price recovery is about to flatline

• Why there's no need for another interest rate hike

• Global inflation edges up but it’s only a blip

To the inflation side first.

The rate of inflation is easing. Already, annual inflation has dropped from a peak of 8.4 per cent in December 2022 to 5.2 per cent in August 2023. With slower economic growth and disinflation pressures in the international economy, Australia’s inflation rate is poised to fall below 4 per cent by December this year, to 3.5 per cent in the first quarter of 2024 and to 3 per cent or less by the middle of 2024.

Three cheers for low inflation.

Now to wages.

According to the Wage Price Index compiled by the Australian Bureau of Statistics, annual wages growth has accelerated nicely in recent times, from a record low around 1.5 per cent in 2021 and early 2022 to 3.6 per cent in the June quarter of 2023. While this is still below the rate of inflation, the gap between wages growth and inflation is rapidly closing.

This brings us to cost-of-living issues as 2023 draws to a close and the door starts to open on 2024.

Even though there are signs of some softening in labour market conditions - with a fall in job vacancies and a path towards higher unemployment - solid demand for workers and rulings for pay increases from the Fair Work Commission are set to see annual wages growth hover around 3.75 per cent for the remainder of 2023 and well into next year.

This means that during the first half of 2024, with wages growth of 3.75 per cent and inflation easing to 3.5 per cent - then 3 per cent or less - real wages will be turning positive – that is, wage increases will be outpacing the rate of inflation.

To be sure, it is not the sort of rise in real wages that will see workers doing cartwheels of delight on their way to work, but it will deliver some relief and will be a turn for the better on cost-of-living pressures.

In itself, this is good news but, from a macroeconomic perspective, it will provide a good point for workers to gain confidence in the economy and, slowly but surely, ramp up their spending.

This is one reason why the economy is set to register stronger growth through the course of 2024. Household consumption spending will lift from the current mire.

There is, however, one potential spanner in the works for this improving scenario: unemployment.

Consumer sentiment and incomes are obviously heavily influenced by the health of the labour market, which means changes in unemployment, underemployment, hours worked, and expectations for job security can all impact trends in real household income levels and spending.

If these factors are negative to a significant extent into 2024, there will be pockets of weaker household spending just when the positive effects of rising real wages are kicking in. This is why no one, including the Reserve Bank, wants to see the unemployment rate increase beyond 4.5 per cent during the current economic downturn.

It is clear that materially higher unemployment, a reduction in hours worked for those who hold their jobs, and a deterioration in job security are all negatives for the household sector and spending.

At this stage, these negative influences are well contained and the combination of decent wage increases with lower inflation will see real wages rise and, with that, consumer confidence and spending track higher.

If interest rates remain on hold in the near term and are eventually cut in 2024 - as the market is pricing in - cost-of-living pressures could reverse from the recent pressures most householders have been experiencing to something quite favourable.

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