Jobs and inflation to trigger higher rates?

The labour market is strong, with higher employment levels than pre-COVID, a record participation rate and a low unemployment rate of four per cent. Alongside increasing inflation, that’s enough trigger a rise in the official cash rate by the Reserve Bank of Australia (RBA), most likely when the RBA board meets on Tuesday (3 May).

The pace of Australian jobs growth slowed last month, but that was expected given the strength in the market previously. For March, employment was up 17,900 and annual employment growth remained firm at 2.6 per cent. Full-time jobs rose by 20,500 while part time jobs dropped 2,700.

So why is the labour market so strong?

1. The economy has recovered since the pandemic driven downturn of 2020, helped by the significant monetary and fiscal stimulus.
2. The closed international border reduced the supply of labour.

At four per cent, the unemployment rate is at its lowest level since August 2008, and it’s expected to dip below that level in the next few months. Any drop would push it to its lowest level since the 1970s.

Labour underutilisation – which combines the unemployment rate and the underemployment rate to give a measure of spare capacity in the economy – fell further in March. It is now 10.3 per cent, well down from the 14 per cent underutilisation rate in the years before the pandemic.

Underutilisation is an important data point for predicting wages growth. For example, underutilisation in the United States (US) is still lower than in Australia which in part explains the higher wages growth in the US versus Australia (5.6 per cent compared to 2.3 per cent).

Will the labour market keep expanding, or has it peaked?

Leading indicators of employment growth, such as job advertisements and business surveys, show robust hiring intentions among firms. Solid employment growth is set to continue, though are unlikely to remain at recent high levels.

March job ads data remained strong, growing by 0.4 per cent, after an upwardly revised 11 per cent surge a month earlier. Job ads are up 50 per cent from February 2020, ahead of the pandemic.

What about wages growth?

It’s only a matter of time before official wages growth data shows a pick-up in wages. Business surveys and anecdotal commentary, along with commentary from the RBA’s own liaison program, all point to wages pressure in the economy.

Together with the underutilisation in the market, we forecast wages growth will hit three per cent per annum by the middle of the year.

That’s sooner than the forecast by the RBA which doesn’t expect wages growth to reach three per cent until the middle of 2023.

Notwithstanding our forecast, wages growth in Australia has been less than many other economies including the US, despite the fall off in immigration during the COVID period.

Why?

During the pandemic, labour supply changed. In Australia we have seen thousands of people re-entering the workforce. The participation rate is much higher than before COVID, whereas in the US the participation rate is still lower than where it was before COVID.

The acceleration in the local economy has created a good environment for workers and that’s encouraged people to enter the labour force. There hasn’t been a labour supply crunch, like there’s been in the US.

Also, because the way the Australian system works, wages are stickier. There is a relatively large proportion of the workforce under enterprise bargaining agreements, and they are set for a year. Wages don’t move as fast.

We will find out just how much wages are growing when the Bureau of Statistics releases its Wage Price Index series for the March quarter on May 18.

What does the labour market mean for interest rates?

The RBA wants to see inflation and wages growth sustainably within its target bands before moving on interest rates.

The RBA’s preferred measure of underlying inflation, the “trimmed mean”, was 1.4 per cent higher over the March quarter or 3.7 per cent over the year. That higher-than-expected rise is likely to trigger an increase on the official cash rate even before March quarter wage data is released on May 18.

The increase in domestic inflation should see the RBA starting to raise interest rates next week by up to 40 basis points, followed by further hikes until the cash rate hits 1.5 per cent by the end of the year.