The most concerning aspect of today’s [GDP] report from an inflation perspective was the surprise jump in the national accounts measure of wage costs. Average non-farm compensation per employee jumped by 2.4%q/q. While this series can be variable on a quarterly basis (the previous three quarterly readings were 0.2%, 0.3% and 2.6% q/q), the annual rate of growth picked up to 5.7%, y/y, the highest rate since Q3 2007.
This is the broadest measure of labour costs which includes wages and salaries, overtime, bonuses, paid leave, superannuation, taxes on employment, training and recruitment costs and fringe benefits. The Wage Price Index on the other hand, which increased a modest 0.8% q/q and 3.8% y/y in Q1, is a very pure measure of hourly rates of pay excluding bonuses which removes the impact of changes in the quality or quantity of work performed. Average non-farm compensation per employee is the measure which directly feeds into most models of inflation via unit labour costs. (Note that nominal non-farm unit labour costs did spike up by 3.2% in Q1, although this is also due to a deterioration in measured labour productivity which has been distorted by the impact of the floods on headline non-farm GDP).
When one considers the relative tightness of the labour market, there appears clear scope for further acceleration in non-farm average compensation per employee. The unemployment rate averaged 5% in Q1. The last time the unemployment rate was at the same level, growth in average non-farm compensation per employee was lower at around 4.8% y/y. In addition, we are forecasting the unemployment rate to drop below 4½% over the next 12 to 18 months. This last occurred from 2007 and coincided with a spike up in the national accounts measure of wages of over 7% y/y.
