A persistently tight labour market is a key concern for central banks as they try to contain inflation. Tight labour market conditions provide bargaining power to workers potentially allowing wages to be bid up to cover inflation and more, adding to the likelihood that high inflation becomes embedded. Australia’s September labour force report, released last week, provides some evidence that labour market conditions and that makes it more likely that the RBA can keep the cash rate unchanged at 4.10% through the remainder of this year, unless there are any substantial upside inflation surprises compared with the RBA’s current forecasts.
Returning to the September labour force report and evidence of a less tight labour market, employment growth at 6,700 in the month, but with full-time jobs falling 39,900 is the first sign of a softer labour market. The drop in full-time work also contributed to less hours being worked in the month, down by 8 million hours, or 0.4%, to 1,930 million hours.
Another sign of labour market conditions easing in September was people ceasing to look actively for work. The labour force participation rate came down from its peak reading of 67.0% in August to 66.7% in September. That reduction in the participation rate promoted the quirky result that even though employment growth was weak in September the unemployment rate fell one notch to 3.6%.
Mostly a lower unemployment rate is a sign of a tighter labour market, but in circumstances where it is likely that monthly employment growth will continue below about 30,000 a month, the unemployment rate will not stay down, but will start to rise. A rough rule of thumb is that given an unchanged participation rate, it takes a 30,000 lift in employment to keep the unemployment rate steady.
The economic force that is starting to temper demand for labour is slowing economic growth, particularly slowing household spending growth. Real GDP rose 0.4% q-o-q in both Q1 and Q2 2023 with real household consumption up only 0.3% in Q1 and 0.1% in Q2. Previously, in much of 2022, GDP rose 0.7% q-o-q each quarter Q2 through Q4, while household consumption rose 2.2% q-o-q in Q2 2022, 0.8% in Q3, and 0.3% in Q4.
Clear-cut deceleration in GDP growth and household consumption growth in the first half of 2023 compared with much of 2022 reflects mostly the impact of tighter monetary conditions adding to cost-of-living pressure for many households and tempering their spending. That has in turn capped and started to reverse the post-pandemic-shutdown surge in demand for labour.
Employment rose an average 43,000 a month through 2022. In Q1 2023 average monthly employment growth was still very strong at 47,800, but then slowed to an average 29,900 in Q2 and 23,000 in Q3. The slowing demand for labour is also meeting better supply with the sharp lift in migration numbers over the past 18 months.
The minutes of the early September monetary policy meeting noted that on an assessment of labour market conditions that included but went beyond the monthly labour market reports there were signs that overly tight labour market conditions were starting to ease. The September labour force report provides further corroboration of that assessment.
That means that even if wage growth reports due over next month or so are a little high, they may not force the RBA to hike rates because the strong likelihood that the unemployment rate will drift upwards soon will temper wage demands further down the track.
But while the RBA may be becoming more comfortable that labour market developments will not derail efforts to bring down inflation it still recognises that currently inflation is too high and there are other pressures that could potentially keep inflation too high for too long.
The escalation in house prices may cause a lift in household wealth and possibly household spending unravelling the downward pressure on inflation from decelerating demand pressure to date. There is no evidence of this possible change so far, but it means the RBA is on data watch with little appetite to take any chances if there are signs of resurrection in demand growth.
Also, the growing crisis in the Middle East is threatening to keep petrol prices under upward pressure. The longer that upward pressure persists not only does it add to current inflation readings, but it adds to business costs potentially threatening to keep inflation higher for longer.
In short, even with promising signs of easing in tight labour market conditions, the RBA cannot tolerate any evidence that inflation is going to stay higher for longer than where it was forecasting back when it produced the August Monetary Policy Statement. Those forecasts had inflation retreating just inside target 2-3% in late 2025. For that inflation forecast to have any chance of happening annual inflation must be near 5% y-o-y in the Q3 readings out this week for the underlying and headline CPI inflation rates.
The consensus forecasts for the Q3 inflation report on Wednesday are CPI 1.1% q-o-q, 5.3% y-o-y; trimmed mean 1.1% q-o-q, 5.0% y-o-y; and weighted median 1.0%, 5.0% y-o-y. Inflation at or around those readings will probably keep the RBA on hold, but anything materially higher could force another rate hike at the November 7 policy meeting. We continue to forecast the RBA staying on hold at 4.10%, but it is another close call.