Opinion: Wages growth is slowing as Australia’s labour market softens, adding to household cost-of-living pressures. But weaker wages could also help bring inflation down faster, opening the door to earlier interest rate cuts, argues Stephen Koukoulas
With households facing extended cost-of-living pressures, wages growth is a critical indicator of both the financial strain many Australians face and when those pressures might begin to ease.
Higher wages growth in absolute terms, and especially relative to the inflation rate, is needed to ease cost-of-living pressures.
From an economic policy perspective, wages growth is an important metric in inflation outcomes and RBA forecasts.
If wages growth is judged to be too high, especially relative to productivity growth, businesses may seek to maintain margins by passing higher labour costs on to consumers via price rises.
That is higher inflation.
Wage growth is slowing
Recent data on wages growth shows the opposite happening. Wages growth is low and slowing.
It is a simple rule of economics that wages growth tends to be weak when there is slack in the labour market.
A slack labour market means that business can retain their staff or hire new staff relatively easily with the benefit, for them, of not having to aggressively hike wages, which they would have to do if it was a tight labour market.
Unemployment has already risen by 1 percentage point from the low point in 2023, and with underemployment also rising, the weak wages data are not surprise.
Will wage growth remain sluggish?
In terms of the outlook, the Reserve Bank of Australia issued it updated forecasts for the economy, including wages, in its August Statement of Monetary Policy. This was released alongside its decision to leave interest rates unchanged.
Those forecasts make for stark reading for the labour market in general and wages growth in particular.
For the Wage Price index (WPI), the RBA is forecasting a continuous deceleration in wages growth right through to the end of 2028.
The RBA forecast for the annual increase in the WPI eases from 3.3 per cent in the remainder of 2026 and into 2027 to 3.1 per cent by the end of 2027. It stays at a tepid 3.1 per cent in June 2028 and drops 2.9 per cent by December 2028.
For the record, annual growth in the WPI peaked at 4.3 per cent in December 2023.
If the forecasts for the WPI from the RBA are broadly correct, it means cost-of-living pressures will remain for the next 18 months, even if inflation falls back to the target of 2.5 per cent by 2028.
Disconcertingly, this is likely to weigh on household spending, feeding back into a weaker overall economy, a softer labour market and further downward pressure on inflation.
The potential upside
It is also critical to understand that slower wages growth dampens cost pressures for business. From their perspective, this is positive because weaker labour-cost growth reduces pressure on margins and the need to raise prices.
From an inflation perspective, this is a scenario that will push prices lower. Even though the RBA is forecasting inflation to fall back to target in late 2027, it could fall earlier and faster if the wages momentum slows as the labour market softens.
This has important implications for future interest rate settings.
Following the most recent RBA meeting, money markets were pricing in a roughly 50 per cent chance of a final 25 basis point interest rate hike by the first half of 2027 with steady to slightly lower rates after that.
For those hoping for lower interest rates, this looks to be a worst-case scenario.
Will there be cuts?
While it is too early to seriously contemplate cuts in interest rates, this could change quickly if the moderation in wages growth improves the inflation outlook.
For households, softer wages growth compounds the pressure from the cost-of-living squeeze and weak consumer sentiment. But there is a potential silver lining: a faster ease of inflation could bring forward the start of the Reserve Bank’s rate-cutting cycle.
Lower interest rates would, in turn, help lay the groundwork for a broader economic recovery, eventually supporting stronger activity and lower unemployment.
It is a scenario that is becoming increasingly plausible, even if the path there involves more near-term pain in the form of weaker wages growth and a further rise in unemployment.
Stephen Koukoulas is Managing Director of Market Economics. He has 30 years’ experience as an economist in government, banking, financial markets and policy formulation. Stephen was senior economic advisor to prime minister Julia Gillard, has worked in the Commonwealth Treasury and was the global head of economic research and strategy for TD Securities in London.
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