Stronger-than-expected population growth is helping to strengthen the pricing power of businesses while dampening wage growth, according to the Reserve Bank.

In its latest monetary policy statement, the Reserve Bank updated its economic forecast, which explains why it raised interest rates this month.

As expected, the bank significantly increased its short-term inflation forecast in response to the most recent ABS Consumer Price Index data, which showed an acceleration in inflation in the quarter of september.

The RBA now expects headline inflation and its preferred measure of reduced average inflation to stand at 4.5 per cent for the year ending December, representing an improvement of 0.6 points percentage compared to this basic measurement.

Furthermore, it expects inflation to remain near 4 percent until the middle of next year, before gradually returning to just below its 2 to 3 percent target by the end of 2025.

These forecasts were based on market prices for interest rates, which took into account Tuesday’s rise in the cash interest rate to 4.35 percent.

More interesting are the dynamics behind this persistent inflation and how it affects those segments of society that bear the greatest cost.

“Output growth this year has had a bit more momentum than expected three months ago, which is partly the result of stronger-than-expected population growth, as well as stronger investment growth private and public,” the bank said. noted the economists.

“Business investment and public demand are expected to continue to contribute to output growth in the coming quarters, supported by strong population growth, easing supply constraints and a broad portfolio of projects, particularly for infrastructure public.”

The bank has highlighted personnel and material constraints that are holding back and driving up the cost of many public and private infrastructure projects, particularly in transportation and renewable energy, and the IMF recently requested that some of these public projects are delayed to meet a certain demand. out of the economy right now.

The effects of population growth on inflation roughly “compensate” for each other

The demographic element of the equation is interesting because the RBA concludes, overall, that this does not add to inflationary pressures.

“The supply and demand effects of stronger-than-expected population growth appear to have been broadly offset, while helping to alleviate labor shortages in specific sectors, such as hospitality” , argued the RBA.

“This has helped to contain wage pressures in some affected sectors and geographies, although increased migration has not materially affected overall wage growth.”

However, while increased population growth has not affected wage growth much, it is unclear how this is not contributing to inflation, given observations elsewhere in the RBA statement.

“Australia’s working-age population grew by 2.8 percent in the year to September; this is the strongest rate of growth of the working-age population since the start of this series in February 1979,” the report observes.

“This has supported demand conditions for Australian businesses. In particular, total spending has been supported by strong growth in the number of international students and tourists over the past year. This includes a significant contribution from tourists and Chinese students since the start of 2023, despite a slowing economic recovery in China.

“Total spending, rather than consumption, determines the demand conditions that drive the pricing behavior of consumer-facing businesses.

“However, an increase in international students also supports the supply-side economy, as many students participate in the workforce.”

Translated into economics jargon, more people means more demand, even if everyone cuts their individual spending, and it’s this total demand that determines whether companies can pass on cost increases, and potentially even add a little more profit margin. .

Even more directly, the sudden increase in population is a key factor in the lowest rental vacancy rates and the highest rent increases in decades.

Increasing supply mitigates inflation by ensuring there is an adequate supply of products and services to meet demand, but also by meaning that employers do not need to raise the price of labor further, as they would do if workers were rarer.

The Reserve Bank has noted from various sources, including business relations, that annual wage growth in the private sector appears to have peaked at around 4 per cent.

This resulted in a slight downward revision of its forecasts on the wage price index and a much larger reduction in the results and short-term forecasts for the average hourly wage, which were reduced by 1, 8 percentage point for the year to June and 2.7 percent for the year. year until December, and slightly degraded for next year.

So while the business sector, overall, appears to be doing well, it appears that working-age households are doing the heavy lifting to contain inflation via higher interest payments to reduce their consumption individual and a drop in real wages which is expected to continue until the middle of the month. of next year.