Australian employment growth has been stronger than we thought it would be raising several questions including will the strength continue; will there be upward revision to earlier economic growth readings; and does it alter the outlook for Australian interest rates? Our views on these questions are that near-term employment growth may stay quite firm although the risk of weaker employment growth in 2016 remains. Past economic growth will probably be revised a little higher. Real GDP growth of 2.0% y-o-y in Q2 2015 just does not tally with annual employment growth that has accelerated to 2.7% y-o-y in October. Giving the benefit of the doubt to employment growth implies some upward revision to past GDP data. On interest rates, the RBA has confirmation of its “glass half full” economic outlook, so will take some shifting on interest rates. It seems unlikely that the cumulative news on the Australian economy will shift enough for the RBA to change view much before mid-2016. We tentatively pencil in a 25bps cash rate cut for May 2016, later than we previously thought likely.
Part of the upside employment surprise story comes down to strength in the South-eastern corner of mainland Australia. Annual employment growth in October was well above the national average 2.7% y-o-y in New South Wales, 3.8% y-o-y; Victoria, 3.0% and Queensland, 2.9%. Strong employment growth in these states contrasts with much weaker than national average employment growth in South Australia, 0.4% y-o-y; Tasmania, 0.3% y-o-y; and Western Australia, 1.1% y-o-y.
In the faster employment change states three common factors seem to have been at work driving employment up. Strong housing activity has been one important factor, especially in New South Wales and Victoria. The sharp rise in foreign tourists visiting Australia and an increasing preference for domestic holidays among Australians (both driven in part by the lower Australian dollar exchange rate) has been another factor. Hotel accommodation, restaurants and cafes have been very strong as a result. A third factor has been a lift in spending on services by households, especially big city households.
GDP data takes time to pick-up significant shifts in spending. A lift in housing related spending may only take a few quarters to bed down reasonably accurately. Getting a hold on a shift in spending on services may take years to bed down. In short, the story of GDP growth approaching the reality of what actually happened in the first half of 2015 will take some time to assess with any accuracy. In contrast, for all of its flaws, the monthly labour force survey picks up new jobs emanating from shifts in spending relatively quickly. Hence our view that it is more likely that past GDP growth will be revised higher over time, rather than employment growth revised down to make sense of low GDP growth.
In terms of relatively strong employment growth continuing in the near-term it seems that the factors driving stronger employment growth in New South Wales, Victoria, and Queensland will continue for a few more months at least. Housing activity is in the process of topping out, but housing construction work in progress will be running very strongly for the next quarter or two, generating very strong demand for home building tradesmen. A significant reduction in housing construction is likely to occur however from mid-2016 and with it employment growth is likely to reduce too. The lift in demand from tourism may carry through much of 2016 as may robust growth in household spending on services. All told, employment growth in the three strong employment growth states is likely to moderate through 2016 and probably in the second half of the year.
Other identifiable factors crimping employment growth in 2016 include the continuing wind down of employment in mining and mining services, the beginnings of the big lay-offs in manufacturing cars and parts and probably more rounds of cost-cutting in the bigger financial services companies including the big four banks.
All told, while employment growth looks firm in the near-term there are reasons why it unlikely to stay firm. The RBA sees the Australian economy showing signs of rebalancing and coping moderately well with the single biggest downside threat to Australian economic growth, the mining investment spending downturn. Even the RBA admits that there are downside risks and that it stands ready to ease monetary policy further in need. It seems that need is not pressing while employment continues to grow relatively strongly. Our best assessment is that employment growth is unlikely to soften too much until the middle months of 2016 when we see the RBA responding promptly to the weakness.
Strong employment growth over the past year is enough to delay the RBA from cutting the cash rate further. We still view the delay as not likely to be unduly prolonged, but May 2016, rather than February is now more likely timing for the next 25bps cash rate cut.