More turbulence ahead, but RBA's path to soft landing gets clearer

For months now, Reserve Bank of Australia governor Philip Lowe has been talking about the central bank's desire to bring inflation down while hanging on to as many of the gains made toward full employment as possible.

Achieving this has involved a tricky balancing act between pushing interest rates up enough to dampen the demand fueling inflation without weakening it so much that employers start undertaking mass layoffs.

It is still very much a work in progress and as interest rates have risen there have been notable business failures, particularly in vulnerable sectors like construction. In just one example, Canberra-based firm PBS Building collapsed in March owing more than $40 million to dozens of creditors.

But there are reasons for the Reserve Bank to think that, so far, it is achieving its aim.

It is widely accepted now that inflation peaked late last year and is gradually declining. After reaching 7.8 per cent in the December quarter, the consumer price index eased marginally lower to 7 per cent in the first three months of the year.

Clearly, this is still too fast for the central bank, which earlier this month delivered its eleventh rate hike in past 12 months, taking the official cash rate to 3.85 per cent - its highest point in more than a decade.

As a result, the economy is slowing sharply. The RBA reckons it will grow by just 1.2 per cent by the end of the year, down from almost 3 per cent late last year.

Despite this slowdown, the labour market has remained remarkably resilient. For much of the year, the unemployment rate has hovered around a near 50-year low of 3.5 per cent before ticking marginally higher to 3.7 per cent in April.

And neither the federal government nor the RBA expects to see large spates of mass sackings or workplace closures. Both forecast the jobless rate will increase only gradually over the next 12 months to reach 4.25 per cent this time next year.

Even more happily for the Reserve Bank (if not for workers), although wages are growing faster than they have in a decade, they are not increasing at a rate likely to cause inflationary concerns.

The closely watched wage price index increased at an annual rate of 3.7 per cent in the March quarter, which is a far more modest pace than has been experienced in other advanced economies like the United States, where pay packets are expanding by 7 per cent and across the European Union, where salaries have been growing by almost 5.5 per cent.

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HSBC chief economist Paul Bloxham thinks if wages in Australia continue to grow at current moderate levels, "the RBA may not need to hike further".

In deciding to raise interest rates this month, the RBA board discussed the risk that the longer inflation stayed high, the more likely it was to fuel bigger wages claims by workers. It also noted that weak productivity limited the scale at which pay increases could be sustained without adding to inflation.

The tight housing market has become a key concern as strong demand and limited supply has made rents skyrocket and become one of the biggest contributors to the consumer price index.

The current big influx of migrants is adding to the pressure on housing and infrastructure.

But Mr Bloxham says the increased supply of workers is also helping to contain wage growth, and this may turn out to be more significant.

This influx is happening as demand for labour is easing as the economy cools.

The housing crisis may also be contributing to Australia's modest wages growth - and data lends support to this idea.

The fastest and surest way to higher incomes for most workers is to switch jobs.

This is highlighted by the SEEK Advertised Salary Index, which shows that wages grew at an annual pace of 4.8 per cent in April - significantly faster than the wage price index.

SEEK senior economist Matt Cowgill said in the tight labour market, competition for scarce skills has forced employers to offer higher salaries.

But the ability of workers to switch jobs may be constrained by difficulty finding new places to live, particularly for renters.

Wages may yet accelerate. Mr Cowgill said up to 40 per cent of workers are covered by collective agreements, many of which will yet to be renegotiated, creating the opportunity for further salary hikes.

But for now most, including the government and the RBA, expect wage growth to peak at 4 per cent late this year.

While the Reserve Bank still faced a "tough act" to slow inflation while limiting the increase in unemployment, Mr Cowgill said the chances of the central bank pulling it off had improved.

"It is far from assured and the plane has not yet landed, but it is more plausible now than it was six months ago," he said.

A lot will depend on what happens overseas, but if the Australian economy keeps on the narrow path mapped out by the RBA, then he thinks policymakers at the central bank and in government - both current and former - can claim some of the credit.