Wage inflation sharpens RBA dilemma

The US economy created 216,000 new jobs in March, and its rate of unemployment  fell to 8.8 %.  This added to other indicators of recovery, including an annual rise of 5.6 % in industrial production, to generate some serious optimism about eventual US recovery.

Despite improvement in the labor market, many workers are barely treading water as their wages fail to keep up with rising prices.

Average hourly earnings for all private-sector workers, including salaried employees, were flat in March. Wages have moved little in the past six months despite consistent job gains during that period and for some workers there has been a long decline in 'real' (inflation adjusted) wages.

Compared with a year earlier, average hourly earnings were up just 1.7 % in March. Inflation is running above 2 %, largely due to higher energy and food prices, which means workers' average inflation-adjusted wages have declined.

The massive task of reducing America's multi-trillion budget deficits remains, though the chances of Mr Obama presiding over the process will keep rising if the labor market does.

The US Fed is also reportedly beginning to think about ending quantitative easing (= printing money) and raising interest rates. When this occurs the world will be a safer place, though risks of global inflation will remain at least until US interest rates are normalised.

Growth in China's manufacturing activity rebounded in March, showing growth of almost 15 %, while inflation pressures stayed high even though the rate of price rises eased slightly to 4.9 %.

Other emerging nations are booming, with industrial production growth 3.7 % in India, 7.6 % in Indonesia, 5.8 % in Russia and 2.5 % in Brazil. Inflation in these nations ranges from 6 % in Brazil to 9 % in Russia.

Japan is facing monumental spending on recovery from its triple disaster of earthquake, tsunami and nuclear meltdown, on one estimate adding US$250 to US$ 300 billion to a budget deficit of one trillion.

The European Central Bank is nerving itself to raise its benchmark interest rate this week for the first time in almost three years. The Eurozone's monetary policy will never suits all 17 members of the euro area.  The multispeed Eurozone economy ranges from record expansion to recession with fears of a sovereign-debt crisis.

Compare Germany, with growth of industrial production of 12.4 % and unemployment 7.1  % with Spain, industrial production 6.0 % and unemployment 20.4  %.  Double each unemployment number to allow for underemployment and the size of the gap is evident.

The predicted gradual normalization of interest rates from a record low of 1 % will disproportionately hurt Spain (unemployment 20 %), Greece (almost 15 %), Portugal (11.1 %) and Ireland (14.7 %), while failing to stop inflation threats in Germany.  (All these numbers come from the latest edition of The Economist.)

It is time the leaders of Europe accepted that a single currency and one monetary policy cannot cope with such a disparate collections of economies and allow the weaker nations to devalue and resurrect their own currencies.

With one of the world's stronger economies, the Australian dollar keeps rising, reaching another post-float record of 1.04 US$ overnight.

Australia's manufacturing sector contracted again in March, as it struggles with the increasing cost of raw materials and the impact of a strong Australian dollar.

The Australian dollar is up nearly 30 % against the U.S. dollar since June 2010. Massive capital inflows to stoke our resources sector is the principle reason.  With the economy already close to full employment, resources booming, and our own substantial spending to come on recovery from natural disaster, goods and services inflation beyond the Reserve Bank's target range is all but guaranteed.

The National Broadband authority has decided all 14 tenders for the next phase of its work were too costly and has paused in its rush to spend taxpayer's money. It is time to stop this costly white elephant in its tracks.

Wage claims are on the march, with a weekend report in The Age focussing (as it should) on the relationship between wages growth, goods and services inflation and productivity growth.

The two authors said: 'The Reserve Bank has had a threshold of about 4.5 per cent for wage growth - a combination of 2 per cent productivity and the 2.5 per cent midpoint of the central bank's inflation target range, according to Stephen Roberts, a senior economist at Nomura Australia in Sydney. That limit now was probably 4 per cent or lower, as productivity slowed to less than 1 per cent, he said'.

Yet Wages grew 3.9 % in the three months to December 31 from a year earlier, the fastest pace since the first quarter of 2009.

This is another case in which the Global Financial Crisis came just in time to save the Reserve Bank from the embarrassment of an inflationary surge.

The authors report a jump in wage claims of 15 % in the resources sector, according to a professional recruitment manager.

In addition: In February, the Construction, Forestry, Mining and Energy Union sought pay increases of up to 24 % over four years; The Communications, Electrical and Plumbers Union is seeking annual pay rises of 5 % over the next three years, almost double the inflation rate.

The Board of the Reserve is on the horns of a sharp dilemma. Its senior officers have signalled (deliberately or otherwise) no immediate rate hikes are in prospect.  Its non-executive directors will worry more about obstacles to growth than the threat in inflation.  Its  ex-officio member, the new Secretary of Treasury, has to decide if he is an independent-minded inflation hawk like his distinguished predecessor, John Stone, or a Treasury official loyal to the party who appointed him.

Further rate hikes will push the Australian dollar higher and further squeeze the manufacturing and tourism sectors and make life more difficult for small businesses generally.

Then there is asset price inflation to worry about. Global share prices have resumed rising after a brief correction to the great Greenspan-Bernanke bubble.  The Reserve Bank can do nothing but give advice to Ben Bernanke on this matter. House prices in Australia have apparently stopped rising but there is a general housing shortage which will be made worse as strong population growth is faced for a time by subdued construction. 

The government is spruiking a tough budget, which will allow for a flood levy and big new carbon tax.

The Reserve will be tempted to leave interest rates unchanged until the budget is delivered and assessed.

That would be a mistake, but an understandable one.

If the Gillard government cannot persuade the major unions to go easy on wage claims, it will quickly be seen as an important mistake.