The Australian labour market was still running hot in Q3 and in early October according to the latest wage price index and labour force reports. Annual wage growth accelerated from 2.6% y-o-y in Q2 to 3.1% in Q3, while total employment in October rose by 32,200 and the unemployment rate fell from 3.5% in September to 3.4%, the lowest since 1974. There is no hint in these readings of any beginnings of moderation in labour market strength consistent with annual inflation reducing inside the RBA’s 2-3% target range over the next two years or so. As a consequence, the RBA will need to deliver another rate hike, probably 25bps to 3.10% cash rate, in early December to close out 2022.
Whether the RBA, after the Christmas/New Year break, needs to hike again at the first policy meeting of 2023 in early February, will depend partly on what the Q4 CPI report out in late January shows but more particularly what the November and December labour force reports show relating to labour market tightness and the risks of annual wage growth pushing up quickly above 3.5% y-o-y and of annual inflation basing above 3% over the next two-to-three years.
If annual CPI inflation pushes up above 8% y-o-y in Q4 and the unemployment rate stays down around 3.4% in November and December the RBA will have no opportunity to pause in February and will need to hike the cash rate again. There is a very high likelihood that the Q4 CPI will see annual inflation at 8%, or higher, and that the unemployment rate will stay down in the next two monthly readings.
Factors pushing up the CPI in Q4 include higher energy prices, higher grocery prices and higher housing rent. There are some offsets in moderating prices for some goods, but the quarter-on-quarter CPI rise looks set to come in around 2% pushing the annual change above 8%.
As far as the labour market is concerned, shortages of labour prevail, especially in the service industries. Consumer spending is still exceptionally strong and is unlikely to falter this side of Christmas. Consumer spending also continues to change its spots with less emphasis on goods purchases and more focus on spending on services – eating out and travel in particular.
Demand is strongest (well above pre-covid levels) in service areas struggling the most to employ more workers. At present and for the next few months at least the demand for workers in areas where household spending is strongest is resistant to rising interest rates and is more than offsetting pockets of weakness in interest-rate sensitive areas of the economy such as housing.
Improving supply of labour over time from increasing immigration and greater participation by parents with children as well as the older cohort of the population should go part way towards meeting high labour demand over time. In the near-term, however, with job vacancies above 450,00 and total employment up over 460,000 in the twelve months ending October, the lift in labour supply from immigration and rising participation in the work force are likely to be too small to matter.
The RBA needs to see the unemployment rate lift to around 4% to make a confident and credible forecast that annual inflation will return to 2-3% target by 2025. The RBA’s latest forecasts showing annual inflation at 3.2% at the end of 2024, a sign that it is not confident the labour market will soften enough.
At present, the unemployment rate is still edging lower and adding to upward pressure on wage growth from recent government policy changes supporting stronger wage growth for the lower-paid and more general wage growth by potential legislative changes to the industrial relations framework.
A persistently tight labour market combined with government policy change aimed deliberately at pushing up wages heightens the risk that annual wage growth accelerates and becomes a force supporting high inflation for longer.
In the near-term, the RBA is monitoring the effect of its interest rate hikes so far and whether they stand to moderate household spending growth enough to reduce demand for labour and take down some of the pressure pushing up wages. Wage growth is not too high just yet at 3.1% y-o-y Q3, but it is threatening to become to become too high by early-2023 unless clear evidence appears of some softening in the labour market.
At this stage, household spending remains too strong to allow any softening in the labour market. Retail sales grew 0.6% m-o-m in both August and September and the October reading due early December is likely to be strong as well.
A 25bps rate hike in December is as good as in the bag because of the strength exhibited in September retail sales, the Q3 wage price index report and the October labour force reading. The key economic reports due for release in December and January, notably November retail sales; the November and December labour force reports; and Q4 CPI, are unlikely to show signs of softness that might prevent the need for another rate hike in February.
Our view is that the cash rate currently at 2.85% will rise to 3.35% in February 2023. That could be the peak for the cash rate for this cycle, but it depends upon the first signs of softness starting to show in household spending and the labour market. Like the RBA we will be monitoring the data closely over coming months.