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Kent reiterates the RBA’s view that the unemployment rate should be “little changed from recent levels over the next 18 months”.
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The labour market has been “adjusting more smoothly over the past year” than the RBA had previously thought.
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A stable unemployment rate is consistent with a stable cash rate and therefore the risk of a near‑term cut in rates looks low.
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We see the RBA on hold at 2.0% from here.
RBA Assistant Governor Chris Kent delivered a speech on “Recent Labour Market Developments” at an Economic Society luncheon in Brisbane. Kent was frank in his admission that, “the labour market has been adjusting more smoothly over the past year than we [the RBA] had been expecting.”
Kent’s speech reiterated the RBA’s opinion that the unemployment rate should be “little changed from recent levels over the next 18 months or so, before declining in 2017.” Previously the Bank was of the view that the unemployment rate would gradually rise to around 6½% by mid‑2016.
A significant chunk of the speech was devoted to reconciling the “better‑than‑expected labour market outcomes” with below trend GDP growth. Four possible explanations were put forward: (i) softer population growth; (ii) sharply slowing wages growth; (iii) a shift in the composition of growth towards more labour intensive sectors; and (iv) labour force / national accounts data issues.
Outside of the mining sector, the compositional change in demand towards more labour‑intensive industries in Australia has been underway for decades. But as Kent noted, the fall in the AUD has encouraged, “Australians and foreigners to direct more of their spending to Australian tourism, education and business services.”
This clearly goes some way to explaining the disparity between below trend growth and a flat unemployment rate. For example, the tourism industry accounted for 2.7% of GDP in 2013/14. But it represents 4.6% of total employment in Australia. The evidence of the compositional change shows up in Australia’s services exports which have risen steadily over the past two years. Services imports, on the other hand, have declined. We expect this trend to continue largely as a result of AUD weakness.
In our view, trend growth in Australia has fallen in recent years. This means that there is probably less spare capacity in the economy than some commentators assume. And if we are correct, it means that there is potentially less wriggle‑room for the RBA to cut rates further without putting some upside pressure on underlying inflation.
Overall, last week’s speech doesn’t shift the monetary policy dial. If anything, it further cements the RBA’s view that we are at the peak in the unemployment rate. We agree with that assessment and it’s essentially our views on the labour market that underpin our thinking on the cash rate. While rate cuts are still “on the table”, the Bank’s assessment that the unemployment rate should be “little changed over the next 18 months” means the risk of a near term rate cut look low. In addition, the AUD now looks quite content to be in the low 70s which we view as the ‘sweet spot’ for the RBA. We see the RBA on hold at 2.0% from here.
