• A single paragraph in the RBA’s minutes is a big talking point for markets.
• It’s about a mystery seen in many advanced economies: low wages growth and inflation, despite strong levels of job creation.
• Senior economists say this creates uncertainty on the outlook for interest rates.

Of the 2,949 words in the Reserve Bank of Australia’s (RBA) December meeting minutes, none have created more of a talking point than those in the final paragraph in which the bank discusses the outlook for interest rates.

Here’s the paragraph in question.

Over the prior year or so, the unemployment rate had fallen and inflation had moved closer to target. Members noted that this had occurred at the same time as risks in household balance sheets had lessened. Recent data had increased confidence that there would be further progress on these fronts over the following year. How far and when stronger conditions in the economy and labour market might feed through into higher wage growth and inflation remained important considerations shaping the outlook.

We’ve highlighted the final sentence in the paragraph for a reason.

In just 27 words, the RBA told markets, households and businesses what will play a crucial role in determining what will happen with official interest rates in the year ahead.

Strength in labour market conditions will need to translate to greater wage and inflationary pressures — or at least provide greater confidence that those outcomes will occur — before interest rates begin to rise.

It sounds elementary, but that’s not the talking point on this occasion.

Rather, it’s when the all the pieces will fall into place to allow the RBA to start to normalising policy.

Nobody, including those who sit on the RBA board, know that answer at present.

The bank thinks strengthening business and government investment — along with the likelihood that labour market conditions will remain firm given recent leading indicators — will help lower unemployment and boost wage pressures. But there’s simply too much uncertainty around to build the case for a near-term lift in interest rates.

Indeed, for all the positive undertones within the December meeting minutes, the one thing that stuck out — aside from the wording of the final paragraph — was that the bank remains concerned about the outlook for household spending and wage growth, two key factors that will need to play ball next year if there’s to be an iota’s chance of an increase in official interest rates.

That’s something that Sally Auld, Chief Economist and Head of Australia and New Zealand Fixed Income and FX Strategy at ‎JP Morgan, picked up from the release.

“Looking ahead to 2018, there remain two key uncertainties for the RBA,” she says.

“The first is the outlook for consumption, given slow growth in household incomes and elevated levels of household debt.

“While the RBA minutes point to rather subdued expectations for consumption in the Q3 national accounts, we suspect the 0.1% rise in consumption volumes in the quarter would have been a disappointment to the RBA. And it doesn’t seem that the outlook for Q4 consumption is much improved, with the minutes noting that ‘moderate growth in consumption had continued into the December quarter’.”

And linked to that uncertainty, and perhaps explaining why household consumption grew at the weakest level since the global financial crisis last quarter, Auld says that the second uncertainty is the outlook for wage growth.

“On this front, the experience of the advanced economies should temper the RBA’s expectations, given that sustained declines in the unemployment rate across G10 economies have not yet delivered much in the way of wage or inflation pressures,” she says.

In her opinion, while the RBA does a good job of “accentuating the positives” within the Australian economy, these areas “have few implications for the setting of interest rates… [while] consumption and wages growth remains elusive”.

On that score, Auld thinks the RBA is likely to be disappointed by what will likely play out next year.

“Our broad forecast set for [the first half of 20148] envisages a moderation in employment growth, stability in the unemployment rate and still subdued consumption outcomes,” she says.

“If realised, this will ensure the RBA remains firmly on hold into 2018.”

Westpac’s Chief Economist, Bill Evans, shares a similar view to Auld.

“Westpac has a more cautious view on the sustainability of the current jobs and business environment while expecting that soft income growth and high debt levels will continue to constrain the consumer,” he says.

“We note that even the RBA now describes household consumption as a ‘significant risk’.

“Accordingly, we do not expect to see the necessary conditions which are outlined by the RBA to emerge over the course of 2018. We retain our view that the overnight cash rate will remain on hold in 2018 and 2019.”

While Evans sees no change in official interest rates for at least two years, he agrees that the final paragraph of the December minutes “clearly lays out the compass for policy”.

“Strength in the labour market and expected associated spill-over effects is expected to continue, although policy will only be adjusted when it is clear that wage and price pressures return,” he says.

Ivan Colhoun, Chief Markets Economist at the National Australia Bank (NAB), is another who thinks that the RBA is “awaiting some more concrete indications that wages growth is picking up or is set to pick-up”.

“At the very least that will require the unemployment rate to continue to decline — something we expect to be more noticeable in the first half of next year — but [given what’s been seen abroad] even low unemployment in some countries is not convincing central banks that there is not greater spare capacity in the labour market than conventionally measured or other more enduring structural factors are at play,” he says.

Colhoun believes the RBA will probably be guided by how “wages respond in overseas jurisdictions with tighter labour markets than Australia”.

As opposed to JP Morgan and Westpac, the NAB expects the RBA will begin to lift interest rates in the second half of next year as wage and inflationary pressures slowly build.

Like the NAB, David Plank, Head of Australian Economics at ANZ Bank, is another who thinks the RBA will begin to lift rates next year.

However, given the degree of uncertainty as to whether wage pressures will start to build, he’s pinpointed one key data release that could change the outlook for interest rates in the second half of next year.

“The Q4 wage data due on 21 February is shaping up as the key domestic release for the first half of 2018,” he says.

“If these data suggest that the apparent softness of the Q3 wage print was misleading then we think the RBA will still be on track to tighten in 2018.

“If, however, the Q4 wage data confirms that underlying wage growth slowed in the second half of 2017 we think it will be difficult for the RBA to be confident enough in the outlook to tighten for some time.”

According to data released by the Australian Bureau of Statistics (ABS), hourly wage growth excluding bonuses grew by just 0.5% in the September quarter of this year, missing forecasts for a larger increase of 0.7%.

A 3.3% increase in Australia’s minimum wage rate rate at the start of July was expected to boost quarterly wage growth by 0.2 percentage points, meaning that without this temporary boost, it would likely have been a record-low quarter for wage growth.

Coming at a time when Australian employment has grown at the fastest pace in over a decade, this has understandably created doubt, and concern, as to whether wage and inflationary pressures will build in the years ahead as the RBA is currently forecasting.

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