Australian Market Strategist
Summary: The Reserve Bank of Australia’s June meeting is likely to be an even closer call than the May meeting in terms of whether the central bank will move to cut the official cash rate.
The central bank has remained optimistic that the labour market will strengthen, and inflation will return to its target range, allowing it to sit on its hands despite continuously missing its 2%-3% inflation target range over the past three years, in addition to tepid wage growth and heavily overleveraged Australian households struggling under the weight of a declining property market.
So, with the spotlight on jobs, last week’s notoriously volatile April employment data was crucial to the outlook for monetary policy. And whilst unemployment rose to 5.2%, the highest level since August 2018, the report wasn’t all bad; employment rose by 28,400 vs. 15,000 expected, employment growth picked up from 2.44% to 2.58% on an annual basis and participation is now at record highs as a percentage of the working age population.
The driving force behind the pickup in unemployment was for “good” reason. The participation rate refers to the total number of people who are currently employed or in search of a job (the labour force) as a percentage of the working age population. This means the uptick in unemployment reflected the increasing size of the labour force. The latter is generally good for the economy more broadly but not so good for stimulating wage price pressure to materially boost wages as the increasing labour force size is outpacing actual hiring.
On the subject of wage growth, if we unpick the data further, spare capacity remains an ongoing issue for the RBA, preventing material upward pressure on wages. This is especially problematic for overindebted Australians battling a negative wealth effect inability to maintain spending in an economy heavily reliant on consumption (historically around 60% of GDP), and pervasive weak inflation trending in the wrong direction.
Underutilisation is a broader measure of spare capacity than the unemployment rate and this picked up from 13.3% to 13.7%. Underemployment (those employed but wanting to and available to work more hours), another measure of labour market slack, also rose from 8.2% to 8.5%, meaning nearly 2 million people in Australia have work but want to work more hours. Combine stagnant wage growth, labour market slack and an economy heavily reliant on private consumption and you have an ugly cocktail for sub-trend economic growth and underwhelming activity.
This means tomorrow will be an important day for RBA watchers, Governor Lowe’s speech could be vital in resolving the current confusion surrounding the central bank’s reaction function – a lack of clarity from the RBA that has left market participants second guessing whether the goalposts for a rate cut have shifted. Governor Lowe’s speech titled "The Economic Outlook and Monetary Policy" will be crucial to gauge the goalposts for rate cuts given Lowe has previously used speeches to provide monetary policy guidance (February). The minutes of last week’s May monetary policy meeting will also be released on the same day, so current ambiguity surrounding the begrudging easing bias could be rectified in the minutes also.
By year end we are likely to have seen 50 basis points of cuts from the RBA, but the timing of these cuts is uncertain, hence the importance of tomorrow's speech. The RBA to date remains too optimistic about the domestic outlook and easier monetary policy may be unavoidable if the weakness in leading indicators of labour market demand are to be believed. Governor Lowe will likely signal that the bank's finger is on the rate cut trigger, but the RBA will hold off on pulling that trigger until at least July.
Given that unemployment has now risen from 4.9% to 5.2% and spare capacity also picked up if the RBA wanted to cut in June, it could justify that move. Several leading indicators are pointing to a slowdown in hiring ahead; ANZ job ads, the NAB business survey employment index, capacity utilisation, SEEK job ads also contracted 10% in April.
But the RBA is behind the curve and has shown its hand in not being pre-emptive, given that it has been so reluctant to ease it is likely it will need two or three months of labour market data to confirm the trend after robust employment growth in Q1 and record levels of participation.
On that basis cuts are unlikely to be imminent, given that labour market data is notoriously volatile. The standard error on the change in employment each month is around ±30,000, therefore labour market data’s inherent volatility means a reluctant central bank will require consistent data deterioration to cut rates. By that time, flagging growth momentum and the weakness pointed to by several leading indicators may have caught up with the labour market already. So with rate cuts likely an inevitability we await Governor’s Lowe's speech tomorrow for clarity on timing.