RBA one precarious step away from ‘policy error’

Seek’s jobs data released in April year showed the downward trend.

Much is made about how central bankers fret over rising inflation, but there’s really nothing like a sudden and sharp rise in unemployment to focus their minds and force them into action.

That’s the situation now facing the Reserve Bank of Australia, which could find itself guilty of committing a policy error if it passes up the opportunity to cut interest rates at its board meeting in mid August.

Data released Thursday showed Australia’s unemployment rate unexpectedly rose to 4.3 per cent in June, following a second consecutive month of weak hiring. The June spike broke a trend of nearly half a year during which unemployment held steady at 4.1 per cent.

The labour-force data, which revealed a significant drop in full-time employment, follows a decision last week by the RBA to not cut interest rates, despite weak economic growth and inflation returning to acceptable ranges.

Money markets were close to 100 per cent priced for a cut, and the disappointment surrounding the RBA’s decision generated anger from traders and economists who pride themselves on their ability to anticipate central bank moves.

By last week putting a rate cut on hold to await the release of second-quarter inflation data at the end of this month, the RBA hasn’t yet committed a policy error.

But it’s getting closer.

To be sure, the clear shift in the labour market means that a verdict of “guilty” will fall hard on the RBA if it keeps interest rates on hold next month.

Rising unemployment means the RBA will confront intense pressure from Canberra to cut; Treasurer Jim Chalmers is already frustrated that the central bank has dragged its feet this year, having cut rates by only 50 basis points.

The caution exhibited by RBA governor Michele Bullock may yet be validated if the second-quarter inflation numbers ring alarm bells but she will still have a very difficult task of explaining another no-cut decision next month, given that the economy is now shedding jobs.

To its credit, the RBA was cautious as inflation spiked globally in the years after the pandemic. It chose to not stomp on the economy with aggressive rate increases, while other central banks felt free to do so.

The benefit of this measured approach has been the retention of high employment levels across the economy – at least until now.

The unemployment rate has hovered near its lowest levels in half a century, with employers largely shrugging off high interest rates and, more recently, the growing threat of a slowing world economy.

The big risk for the RBA now is that the employment gains erode quickly, creating a visible sign of policy failure.

The RBA has the ammunition to forestall a bigger rise in unemployment given that the official cash rate is still well above what most economists would consider a neutral rate.

The danger, of course, is the return of inflation.

Still, the RBA has shown a tendency to get a little too jumpy about short-term movements in the inflation numbers, fussing too much about hitting the midpoint of its 2 per cent to 3 per cent target band.

Policy makers need to refocus on the broader goal of keeping inflation within the target range on average over the course of the economic cycle.

There are too many currents in the global and domestic economies that can temporarily swing the inflation needle away from the midpoint, resulting in hesitancy by the bank.

The pressure cooker around the RBA is building. It will likely take a truly disastrous inflation figure in the coming weeks to scuttle an August rate cut.

The Wall Street Journal