The Fair Work Commission delivered a 3.5 per cent increase for employees on industry awards and the minimum wage on Tuesday.
In handing down a figure substantially above inflation, the commission sided with the federal government's call for a "sustainable" real pay rise, finding it was unlikely to be detrimental to the economy, despite weak productivity growth.
President Adam Hatcher said the decision would help correct a decline in living standards for employees over the past three years.
In previous years, the commission was discouraged from awarding a pay increase that would enable low-paid workers to catch up with rising costs because of concerns it could cause inflation to become more entrenched.
Now the inflation spike was over, it was important for the commission to correct a 4.5 per cent fall in the real value of wages since 2021, Justice Hatcher said.
"We are concerned that if this opportunity is not taken in this annual wage review, the loss in the real value of wages which has occurred will become permanently embedded in the modern awards system and the national minimum wage," he said.
"And a reduction of living standards for the lowest paid in the community will thereby be entrenched."
The decision is roughly in the middle of the range of suggestions made by unions and business groups.
In its submission to the commission's review, the Australian Council of Trade Unions called for a 4.5 per cent increase.
Despite the decision undershooting her demands, council secretary Sally McManus said it was a "great outcome" for low-paid workers.
"(An increase of) 3.5 per cent means they're starting to catch up again, and that makes an enormous amount of difference in terms of people's bills, people's ability to pay for the basics," she told reporters in Melbourne.
But employer groups warned businesses were struggling to get by on razor-thin margins and a pay rise of this scale would force many to lay off staff or close.
"Small businesses are facing a cost crisis across energy, rent, insurance and input costs," said Council of Small Business Organisations Australia CEO Luke Achterstraat, who argued for a 2 to 2.5 per cent rise.
The Australian Bureau of Statistics reported prices rose by 2.4 per cent in the 12 months to March 2025, which would amount to a real increase to award wages of about 1.1 per cent - one of the highest granted by the commission.
Prime Minister Anthony Albanese said it was a modest increase but a welcome one.
The government supported the decision to ensure low-paid workers did not fall behind, he said.
The decision will overwhelmingly affect workers in accommodation and food services, health care and social assistance, retail trade and administrative and support services, which account for over two-thirds of award-reliant employees.
About one in five workers are covered by the decision, which follows an increase of 3.75 per cent in 2024.
But the impact on inflation will be minor, given awards are disproportionately low-paid and part-time and as a result only contribute about 10.5 per cent of the national wage bill.
RBC Capital Markets' chief economist Su-Lin Ong estimates the decision will add less than 0.1 per cent to the wage price index.
The minimum wage will rise by 85c to $24.95 an hour. The new pay rates will kick in from July 1.
The commission's next priority will be to review gender-based undervaluation of female-dominated jobs in white-collar fields, including English teachers, architects, paramedics and law graduates.
Its last gendered undervaluation review recommended wage rises of up to 30 per cent for workers in childcare, health and other feminised sectors.
