Annual inflation may have come down to 6.0%pa, but businesses and households alike are still facing extreme cost pressures. A massive influx of migration and a high number of people returning to work has helped to alleviate some labour market pressures, and yet some underlying wage measures are still accelerating, which risks wage inflation remaining higher for longer.

Labour costs have continued to rise rapidly over late 2022 and early 2023, even as momentum in the consumer price index (CPI) comes down (Chart 1). Average hourly earnings have been growing at around 7.0%pa for around a year, and adjusted labour cost index (LCI) inflation has held above 4.0%pa since December 2022. While the goods-based inflation component of the CPI decelerated one percentage point to 6.0%pa between the March and June 2023 quarters, services-based inflation held at 6.1%pa, reflecting how the tight labour market is continuing to push up prices.

In July, we commented that stubborn wage pressures would worry the Reserve Bank. A key inflationary risk of persistently high labour costs is that of a “wage-price spiral”, where higher living costs cause workers to demand higher wages, which in turn causes businesses to raise prices, causing higher living costs, and so-forth. The Bank’s concerns were subsequently reflected in the August monetary policy review, with an upgrade of their peak official cash rate (OCR) forecast from 5.5% to 5.6%. This upward revision is not a definitive announcement of higher interest rates, but indicates the Bank believes there is now a higher probability of a further OCR hike, and underscores the important role that wage pressures play in maintaining price stability.

The adjusted LCI has been accelerating at its fastest rate on record from data dating to the early 1990’s. The adjusted LCI measures salary and wage shifts for a fixed quality and quantity of labour, so for example if someone’s salary is raised due to them taking on a more advanced role or working more hours, this doesn’t contribute to movements in the adjusted LCI.

Over the past two decades, labour costs across the private sector have generally risen at a similar rate to local government, and faster than central government (Chart 2). Local government costs are now accelerating at an unprecedented 5.1%pa, 0.8 percentage points ahead of the private sector.

Chart 3 shows how across occupations, wage pressures in the June quarter were most intense for trades workers and clerks (administrative office roles). Labour costs have risen more than 4.0%pa for all occupations except legislators and managers.

On average across all occupations, the labour cost index has maintained annual growth over 4.0%pa in the last three quarters. Between the March and June quarters, labour cost increases held steady or eased across most occupations, but continued to accelerate for service and sales workers, and trades workers.

Stats NZ’s Quarterly Employment Survey (QES) offers insight into earnings across industries. Average hourly earnings increases have decelerated from a peak of 7.6%pa in the March 2023 quarter, to 6.9%pa in June, but remain considerably above the long-term average. A single quarter of data is not yet definitive evidence of a slowdown, but does indicate some stabilization. Earnings are still accelerating across several key industries, including utility (electricity, gas, water, and waste) services, education, forestry and mining, and public administration.

Notably, earnings inflation in utility services lifted 4 percentage points between the March and June 2023 quarters, to 10%pa. Earnings growth in the education and training industry accelerated for the third consecutive quarter to 8.0%pa.

Currently, the most rapid earnings growth is in utility services, followed by health care (8.6%pa), construction (8.5%pa), information media (8.4%pa), and retail trade (8.1%pa). Accommodation and food services, and rental/real estate services, were previously hot spots for earnings inflation, rising 11%pa and 10%pa respectively in the September 2022 quarter. These industries have since seen softer earnings growth, easing to 5.8%pa and 4.6%pa respectively in the June 2023 quarter.

Amidst all this alarming news of rising labour costs and risks of still-higher interest rates, a key trend is nonetheless emerging across the economy: the labour market is becoming less tight.

In the June 2023 quarter, the working-age population expanded by 25,000 people from the previous quarter (seasonally adjusted), and there was a 10,000-person reduction in the size of the ‘not in labour force’ group. The unemployment rate ticked up to 3.6%, driven by a faster increase in people looking for work compared to job availability. Overall, more capacity is becoming available, and labour cost measures showed signs of stabilising in June.

Over time, less tightness in the labour market is expected to reduce wage pressures. For now, labour costs are still growing at record speeds and will be closely monitored by the Reserve Bank as they continue to review monetary policy settings.