Australia’s 1.5 million lowest paid workers will get an $18.70 a week pay rise from July 1.

The Fair Work Commission announced a 3 per cent increase to the national minimum wage, which will now be $640.90 a week.

The hourly rate will lift by 50c to $16.87.

The increase falls below the $27 per week rise the ACTU argues is necessary to avoid creating an underclass of working poor, but will disappoint business groups who argue they can only afford an extra $8.50.

Fair Work Commission president Justice Iain Ross said the wage rise was appropriate given pay inequality in Australia was increasing.

“While real earnings have generally increased over the past decade, earnings inequality is increasing,” he said.

“Over the past five years, the rate of growth in average earnings and bargained rates of pay have outstripped the growth in minimum wages for award-reliant workers.

“This has reduced the relative living standards of award-reliant workers.”

Justice Ross said Australia’s economic outlook remained sound, with employment growth expected to be stronger in 2014-15 and inflation contained.

Working against those factors are a continuing high youth unemployment rate and a falling full-time employment to population ratio.

He said the superannuation guarantee rate increase set to take effect from July was a moderating factor, but he said the Fair Work Commission did not take into account the proposed repeal of the carbon tax.

“We have decided that the range of considerations we are required to take into account favours the award of an increase which will result in a modest improvement in the real value of modern award minimum wages,” Justice Ross said.

Shadow employment spokesman Brendan O’Connor welcomed the increase but said the government had an agenda to cut penalty rates.

“Hard-working Australians who are on a low rate deserve a decent life,” Mr O’Connor said.