Jul
27
Written by:
Moyle Consulting
Tuesday, July 27, 2010 10:21 AM
The CPI rose 1.8% for the year to June 30, slightly lower than the 2% many were expecting. Aside from a big increase in the price of cigarettes and tobacco due to an increase in excise duty, the other (modest) price increases over the last quarter were for transport, housing and household utilities. A drop in prices was witnessed for recreation and food.
Employers could be excused for breathing a sigh of relief as relatively low inflation often signals a softening in demand for pay increases. If prices haven’t gone up much, pressure on salary and wage increases to cover the cost of living should diminish. That should be good news as we continue taking tentative steps towards economic recovery. But what this result could also be telling us is that many businesses are still in a wait and see mode and don’t feel confident enough to increase prices. Recent international share market fluctuations have reminded many that we are not out of the woods yet.
Whatever this result means, inflation will be watched closely over the next few months for what it tells us about the economic recovery, but also about expectations for pay increases. It has been clearly forecast that the annual CPI rate is expected to jump to at least 5% later this year, 2% of that from the October GST increase, and 0.3% from fuel and electricity increases due to the emissions trading scheme.
Despite CPI currently being lower than forecast, many economists are expecting the Reserve Bank to continue to raise the OCR in the coming months as the economy recovers. In the June Monetary Policy Statement Reserve Bank Governor Alan Bollard states “headline CPI inflation will be boosted temporarily by the announced increase in GST and other government-related price changes. Provided households and firms do not reflect this price spike in their wage and price-setting behaviours we do not expect a lasting impact on inflation.” The New Zealand Institute for Economic Research supports the Reserve Banks belief that we are not likely to see increased demand for pay rises. Rather, due to ongoing labour market weakness, in the year to March 2011 inflation adjusted wages will actually decline by 3.6%
Personally, I believe this is at best optimistic. A sudden, albeit temporary spike in the CPI could be just the catalyst for a sudden swell in demand for pay increases. ASB Economist Christina Leung disagrees with the conclusion of the Reserve Bank. "At the moment the Reserve Bank is assuming that these changes (GST and ETS) will not flow through to price- and wage-setting behaviour. Given medium-term inflation expectations are already close to the top of the bank's inflation target band, we believe there are substantial risks to this assumption." It seems that the Reserve Bank is desperately hoping they will be right, otherwise they could have a real battle ensuring inflation doesn’t spiral out of control without slamming the brakes on the economic recovery.
Despite the fact that the spike in inflation will not be a surprise, it is sure to grab headlines, and further reinforce the feeling that real income is declining. Unions will be quick to latch on to this sentiment and gear up for a big push for pay increases in early 2011. It does not matter that GST increases are effectively offset by tax reductions, for the average salary and wage earner; they are far more likely to notice the jump on the supermarket shopping receipt or the cost to fill up their car, than they will notice the slight increase in take home pay. The net result will still be one of feeling worse off.
Add to this mix that many workers had no pay increase in 2009 and are likely to receive only modest increases, if any during 2010; headline inflation at 5% could be just the sort of news to fuel general feelings of hardship and spark industrial action around pay. That could set in motion widespread dissatisfaction with pay and create expectations for significant increases as we saw in 2005.
Furthermore, even a slight strengthening of the labour market, which has been forecast by so many it almost seems inevitable, will give individuals and unions further courage to push for a bigger pay rise. The difference between 2005 and now is that we are currently climbing out of a recession, and pay increases may simply be unaffordable for many businesses.
Bill Rosenberg of the Council of Trade Unions believes the Reserve Bank should hold interest rates given the lower than expected inflation and hints at growing discontent around wage growth. "The Reserve Bank overestimated inflationary pressure and underestimated the grounds for concern at the state of the economy. The main concern now is about the impact of GST on inflation heading into 2011 and the pressure this puts on workers and families who missed out on decent tax cuts and have had low or no wage increase."
If this pressure does translate into pay increases this will compound inflation even further as highlighted by Business New Zealand: “a number of businesses and indeed individuals use the CPI as a benchmark for trying to determine a number of outcomes e.g. price increases, contracts or wage rises.” “The danger with a high headline CPI, is that this will be reflected in the generalised pricing decisions and thinking of both businesses and individuals, potentially impacting on generalised inflation, to which the Reserve Bank will have to respond.”
Economic recovery over the next six months will be critical if New Zealand businesses are going to be able to meet demand for pay increases. If the economy has not sufficiently recovered, price increases to cover wage growth will not be tolerated and employers will find themselves between a rock and a hard place, unless they have managed to improve productivity and can pass some of those gains on to staff.
The consolation that “at least you still have a job” may not be enough to satiate demand for more pay as many will have had the threat of redundancy hanging over their head so long they no longer feel it is real. Even though that threat is still very real as there are likely to be continued business failures despite the economic recovery. And even a modest increase in job opportunities will dilute that argument and could be all the encouragement needed for individuals to approach salary review time with a clear agenda for a pay rise.
Jarrod Moyle - Director Moyle Consulting.