What are the implications of the currently strong real wage growth for the Czech economy and Czech asset prices?
The stand-out feature of the Czech economy at this stage of the present economic cycle is tight labour markets and the consequent growth of wages. The country’s record low unemployment rates, the CSU’s measure at 3.2% in April 2018, Eurostat at a seasonally adjusted level of 2.2% in March 2018 is placing Czech labour at a pricing premium. In the absence of a coordinated immigration policy to provide labour, it is no surprise that national wage growth accelerated to 8.0% in Q4 2017. Assessing CSU data, it appears that the number of advertised vacancies (239,100 in February 2018) could exceed the number of jobseekers soon. This is unprecedented in the modern history of the country.
We believe the salary growth trend will continue in 2018, at the same average rate of 8%. At the base of the pyramid, the government increased the minimum wage for this year by 10.9% to CZK 12,200 for a 40-hour week. Key auto producer VW Skoda agreed a 12% wage hike with its workers in April. A notable, healthy feature of 2017’s full-year real GDP expansion of 4.5% was the 7.9% jump in fixed capital formation, indicating that private businesses decided to invest to significantly expand their production and service bases even in the face of the tight labour markets. To staff this expansion, private businesses have to attract labour and thus wages look set to climb again this year.
It is logical to be concerned that such wage rises might render the economy uncompetitive rather quickly. But three factors mitigate this impact for now: first, productivity in Czech industry just about kept pace with the wage rises last year, with the value of manufacturing production (goods produced) growing 7.4% overall. Moderate to high demand from key export markets such as Germany should see manufacturing growth in the 4%-7% range this year, with some softer figures coming in the first half. Secondly, the 2013-17 period of the Czech Koruna being held below the level of 27.0 to the Euro (the “currency cap”) kept Czech wages cheap in a European context. The 4% appreciation of the koruna since the “cap” was removed nearly a year ago has removed a little of this advantage but as a base for comparison, Czech total unit labour costs amounted to just EUR 11.3/hour according to the latest Eurostat data for 2017, versus Germany’s EUR 34.1/hour and the EU average of EUR 26.8/hour. Even at the present elevated growth rates, it would take until the end of the next decade for Czech wages to match the EU average. So, there is room to tolerate further currency appreciation. Thirdly, Germany and especially other CEE countries are also facing wage growth and labour shortage pressures, so the relative loss of competitiveness is most likely lower.
Thinking about potential Czech stock market investments in the same way, the companies would need to grow their revenues as fast as their wage bills are increasing. But at some of the larger companies this did not happen last year. Comparing the personnel expenses and employee growth numbers in the recently-released annual financial statements, the wage bill per employee at CEZ and Komercni Bank grew an estimated 5% and 4% in 2017, whilst overall revenues shrank -1% and -2% respectively. Moneta Money Bank kept its salaries per employee flat overall but openly acknowledged wage inflation pressure as an issue in the face of revenues falling -7%. There are other reasons, aside from productivity, to own these equities.
Looking at other assets, a wage growth expectation of 8% for this year is likely to feed into a higher trend rate of inflation. Retail sales barrelled along at an average 6.0% year-on-year growth rate in January-March 2018. So, consumers are still spending and should push prices up. An inflation outcome at or above 2017’s average CPI of 2.5% will most likely see the CNB increase interest rates further. We see the latter as a negative for holders of longer-dated bonds. But providing some opportunity at the short-dated end of the bond maturity universe.
The gap between wage growth of 8% and inflation in the range of 2-3% is money in peoples’ pockets, so-called “real wage growth”. The CSU saw this surplus at 5.3% in 2017. That excess is either spent (consumption) or saved. It is increasingly being saved through being invested in housing. An 8% wage rise enables an individual mortgage borrower to probably afford a house 20%-30% higher in value, due to the effect of gearing on the size of borrowing. This demand power provides the simplest explanation for the strength of Czech housing prices last year. According to the national HB Index, the prices of flats rose 11.9% YoY and those of houses 7.5% YoY. Even with higher mortgage funding rates to be expected in 2018, another 8% on wages will most likely boost house prices again.