Unemployment rate spike builds pressure on RBA to cut again
Economists say the sharp deterioration in the jobs market makes the RBA’s decision to hold rates steady last month look like a policy error.
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The Reserve Bank won’t exactly be cheering, but the unexpected rise in Australia’s unemployment rate to a 43-month high of 4.3 per cent in June is good news for the inflation outlook.
Even if quarterly inflation data this month don’t show further progress towards the midpoint of its target band, the RBA board should probably get on with interest rate cuts when it meets in August.
The RBA’s post-Covid strategy of tightening monetary policy just enough to rebalance pandemic-era supply and demand has worked.
It was right to cut rates in February and again in May after the trade war escalated. But with unemployment spiking, criticism of its decision to keep rates unchanged last month is growing fast
“The sharp rise in unemployment in June makes the RBA’s decision to leave rates on hold this month look like a policy error,” Capital Economics senior APAC economist Abhijit Surya said.
“We’re increasingly convinced that the incoming data flow will prompt the Bank to cut rates further than most are currently anticipating.”
For the June quarter overall, jobs data wasn’t markedly weaker than the RBA expected. Annual employment growth of 2.3 per cent was above the RBA’s forecast of 2.1 per cent.
The average unemployment rate of 4.2 per cent was in line with forecasts.
However, the unemployment rate hit 4.3 per cent six months earlier than expected.
Surya says the “dramatic shift in sequential momentum” in monthly employment data is “certain to give the RBA cause for concern”.
The RBA expects household consumption to rise as real incomes increase due to falling inflation.
But in its statement last week it saw “a risk that the pick-up is slower than expected, which could result in continued subdued growth and sharper labour market deterioration”.
The latest jobs data suggests that very risk is materialising.
The upshot is that the RBA is almost certain to cut rates by 25 basis points in August.
Economists are sticking to predictions of a 25 basis point cut for now, but 50 basis points could return to the table if CPI inflation data on July 30 confirms benign inflationary pressures.
Surya is now more confident the “terminal” cash rate target will hit 2.85 per cent versus the recent analyst consensus of 3.10 per cent.
The labour market remains tight by most measures, but it’s typically the most lagging economic indicator. GDP per capita has been flatlining and consumer sentiment depressed for years.
If unemployment is inflecting higher after hovering around 4.1 per cent for 17 months, the RBA better get moving or it may be too late to stop a recession. After enduring “restrictive” rates since late 2022, households won’t go on a spending spree just because the RBA cuts rates again.
Goldman Sachs Australia chief economist Andrew Boak continues to expect rate cuts in August after a “surprisingly hawkish ‘on hold’ decision” last week.
“The data also supports our view that Australia’s labour market is no longer ‘tight’ and should not be a barrier for further cuts,” he said.
A key uncertainty is whether the labour market is still operating above full employment and therefore a source of inflationary pressures.
Boak believes the labour market has arrived at a “sweet spot” and is not contributing to inflation.
The jobs market is “balanced” because wage pressures have normalised. Job-finding and job-switching rates – both important wage determinants – have eased materially.
Boak estimates indicators in the RBA key wage signals have returned to historical averages.
His preferred indicators place the non-inflation accelerating rate of unemployment (NAIRU) around 4.25 per cent, slightly below the current 4.3 per cent rate.
By contrast, the RBA’s model-based NAIRU estimates are higher and above 4.5 per cent.
“Greater caution is warranted when interpreting these model-based NAIRU estimates because the post-Covid inflation episode has significantly complicated the modelling,” he says.
Boak was “really surprised” by the RBA’s decision not to cut rates, given “compelling evidence that sequential momentum in inflation has already returned to target across a broad sweep of measures”.
“A backward-looking emphasis on year-over-year changes skews the balance of risks towards an inflation undershoot and the RBA falling behind the curve,” he said.
Citi Australia chief economist Josh Williamson says the latest jobs data raises downside risks after a surprise employment fall of 110,000 in May.
The RBA board’s “reaction function is asymmetric” – poor labour market outcomes are met with dovish rhetoric, while stronger jobs data don’t necessarily lead to hawkish shifts.
“Barring an upside shock on Q2 CPI, we now believe the board will comfortably deliver a 25 basis point cut in August.
“If this trend persists and unemployment ticks up further, it will confirm another 25 basis point cut in September.”
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