Labor Cost Growth - Slipping Below Neutral

The Labour Price Index (LPI) data for the September quarter released this morning showed a very low 0.7% rise. In the last 10 years, there has only been one quarter - September 2009 during the depths of the GFC - when there has been a smaller increase. Perhaps not coincidently, this very low LPI occurred in the same quarter (September 2011) where underlying inflation plummeted to a 14 year low of just 0.3%.

In annual terms the LPI rose 3.6%, a little below the average of the last 10 years and at a pace that is consistent with inflation at worst remaining near 2.5% or more likely, slipping towards 2% or less as we get into 2012.

Note also the soft pace of job creation in the past half year or so, the weakness in job ads and the uptick in the unemployment rate since mid-year. It looks like the LPI will ease further in the year ahead, perhaps to a 3.25 - 3.5% pace.

Not that things in the economy are bad - they are not. But there is mounting evidence that suggests the moderate growth being recorded is opening up spare capacity (see NAB business survey data) and because of this, inflation is set to ease further.

With the December quarter CPI increasingly looking like it could be flat or even negative, the case for interest rate cuts remains compelling. Another 25bp cut to 4.25% would seem prudent in these circumstances. Throw in the fragile conditions in the global economy and it is very hard to see any reason why the RBA will not cut next month.