Will higher commodity prices lead to better wage outcomes this year?

• Wages growth and commodity prices have historically shown a strong correlation.
• Given this relationship the surge in commodity prices which began in mid 2016 is pointing to faster wages growth in 2017.
• However our forecast is for only a modest lift in the pace of wages growth. This is because higher commodity prices are expected to unwind over the year. And mining investment is still falling, not increasing.

The surge in non‑rural commodity prices, which began around the middle of 2016, is boosting Australia’s income at the aggregate level, improving the trade position (there was a $1.2 billion surplus in November!) and lifting government revenues. The sector still yet to benefit is households, with higher commodity revenues not yet filtering through to stronger wages growth.

Wages growth has historically shown a strong correlation with commodity prices. For example, the correlation between annual growth in the Wage Price Index and commodity prices sits at 0.8. Other measures of labour costs, like unit labour costs, which have a longer history show a similarly high correlation. Looking at wages growth excluding the mining sector shows the same strong correlation. This shows that the non‑mining sector also typically benefits when commodity prices increase.

It has been suggested that the decline in wages growth in recent years has been larger than would be expected given historical relationships with economic variables such as the unemployment rate (see RBA, 2016). However looking at the relationship between wages and commodity prices shows that declining wages growth in recent years does not look out of line.

So what about 2017?

The historical correlation with commodity prices suggests that wages growth should lift sharply in 2017. However our forecast is for a more modest lift. This is because the latest run up in commodity prices is generally thought to be temporary. Our commodity analysts are expecting bulk commodity prices to ease in 2017. And the latest government budget update assumes a decline in prices later this year. The mining companies must share a similar view with no significant plans as yet to invest to expand capacity.

This is vastly different from the previous commodities boom where mining investment ramped up strongly alongside rising prices. This caused the labour market to tighten and put upward pressure on wages. This time around there is also a lot more spare capacity in the labour market to work through before significant wage pressures are likely to emerge.

Nonetheless it a positive factor. And another positive sign for wages growth and inflation in Australia is that global disinflationary pressures are easing. Producer prices are now rising, not falling in China. And the US economy is running close to potential even before Donald Trump has implemented his expansionary and inflationary policies. We also expect the AUD to weaken a little over the year, which will put upward pressure on imported prices.