In a speech made to the Australia & Japan Economic Outlook Conference in March, the Reserve Bank Assistant Governor Dr Malcolm Edey highlighted the concern the Reserve held about the fact that “the factors pushing up underlying inflation last year remain in place.”

The markets reacted sharply to Edey’s speech, as they considered it to be unexpectedly hawkish at a time that inflation was appearing to be moderate. Edey said:

The December quarter national accounts recorded relatively strong growth in demand and output. We also have some additional data on wages, which showed that growth in the Wage Price Index remained around 4% in annual terms at the end of last year. This needs to be interpreted carefully, because the September quarter outcome, and hence also the annual figure, were artificially held down by a change to the timing of last year’s minimum wage decision. The outcome for the December quarter, which was unaffected by that, was a quarterly increase of 1.1%, which was at the top end of its historical range.

While the Reserve Bank does say that the underlying measure of inflation, which has moderated, is a good guide to where inflation is going to be in a couple of quarters, they have to look at other factors to gain a better picture of the long-term. One of the main factors that the Reserve looks at is what’s happening to our economic capacity.

Wage growth, in the run-up to the 2007 federal election, is both a key economic and political topic. The Howard Government argues that its WorkChoices legislation is helping to restrain a blowout in wages growth, despite an extremely tight labour market, which has helped inflation remain moderate.

The data certainly supports this suggestion. Today’s ABS Labour Price Index increased by just 1% for the March Quarter, and 4.1% for the year — an excellent result for the Government. This will further convince the Reserve that inflationary pressures remain benign, and that interest rates are on hold.

While Henry is sure that the actual level of unemployment is higher than 4.4% (meaning that we’re not actually running at full capacity), the fact that the labour market appears to keep tightening, without any appreciable impact of wage growth is a great success story for the Coalition.

Despite their poor poll results, the continuing strong economic data will give the Coalition reason to celebrate. All economic growth indicators have recently come in at the stronger end of market expectations while inflationary indicators continue to surprise on the low side. Don’t forget that “It’s the economy, stupid”. 

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