Shortages of labour are a major problem facing most private and public sector employers in Australia. The extent of the problem is illustrated in the June labour force report issued last week and showing the unemployment rate down at a 48-year low 3.5%. Over the last 12 months the unemployment rate has fallen from 4.9% or by 188,500 people and now stands at 494,000 matching almost one-for-one reported job vacancies, 480,000 in May. Before the pandemic there were more than three unemployed people for every job vacancy. Australia has entered over-full-employment which tends to drive faster wage growth adding to the range of factors pushing up inflation at present.

The current wave of covid infections is adding an additional twist to the tightening labour market and one that hopefully is temporary. While the number of people employed in June rose by 88,400, total hours worked fell by 0.1%. This anomaly between more people working and less hours worked is explained by high absenteeism because of illness in June. The ABS media release noted “there was around 780,000 people working fewer hours than usual due to own illness in June 2022, almost double the usual number we see at the start of winter”.

The June labour force survey was conducted between 28th May and 13th June and covid infections have lifted substantially since with health authorities not expecting the current wave to peak until late August. Unusually high absenteeism because of illness will feature in the July,  August and possibly September labour force reports adding to the shortages and disruption to supply of goods and services.

While the health-related reduction in labour supply from higher-than-usual absenteeism can be expected to improve after the peak of the current covid infection wave, more general labour market tightness may persist. It is proving hard to source new workers to meet the demands of an economy has been growing well above 3% annual growth clip and where the driving force of that growth is household spending.

Moreover, easing pandemic restrictions have promoted a shift in household spending with greater emphasis on services, rather than goods that were in high demand during lockdown. Production of services is more  labour intensive than production of goods.

Before the pandemic, Australia could draw on overseas workers to help meet demand for labour. In 2020 and 2021 closed international borders cut off that supply leaving Australia more than half a million workers short of where it would have been otherwise positioned in early 2022 when the borders re-opened. The return of international workers has been a slow affair so far, bedevilled by bureaucratic delays granting visas. The inflow of international workers, around 60,000 in 2022 so far will need to lift considerably to make a material difference to the shortages of workers in Australia.

Meantime, through the pandemic supply of workers has been eked out by getting more people of working age (15 years old and above) into the workorce. The labour force participation rate was a record high 66.8% in June 2022, 0.9 percentage points above were it was in March 2020 at the start of the pandemic. Over that period the male participation rate rose from 70.7% to 71.2% but the female participation rate has done most of the heavy lifting rising from 61.2% to 62.5%.

If the participation rate could lift one percentage point over the next year – a big ask given that it rose 0.9 of a percentage point over 27 months to June 2022 – that would lift the workforce by 210,000 or less than half of the 438,000 lift in employment over the past 12 months to June 2022. The ambitious 210,000 lift in the workforce from rising participation over the next year might be boosted by say 150,000 increase in foreign workers, but that still implies that employment cannot rise as fast over the next year as it has over the most recent 12 month period, and that rise over the past year was not enough to prevent growing labour shortages.

Absent a marked deceleration in demand in the economy more modest growth in the workforce means Australia’s very low unemployment rate will go lower over the next few months, possibly below 3%. Exceptionally low unemployment is already promoting a bidding war for scarce workers among employers in some industries and that is likely to become more widespread. The institutional factors that have served to keep wage growth comparatively low in Australia in the past will be stretched. The wage price index will reflect the pressure building on labour pricing and we see the 2.4% y-o-y annual change recorded in Q1 2022 pushing well above 3.5% in the Q4 report (due February 2023).

The RBA faces a series of monthly labour force reports showing exceptionally low unemployment through to at least the September report due in mid-October. It will also face a series of quarterly wage price index readings extending into 2023 that show much faster wage growth. There will also be high CPI inflation readings out later this month and in late October 2022 and late January 2023.

If the RBA bases its monthly monetary policy decisions on the latest data readings it would be obliged to deliver rate hikes, probably double-sized (50bps) or more, every policy meeting for the remainder of this year extending to the early meetings of 2023. We doubt whether this will happen, because decision making on the basis of the latest evidence of tightness in the labour market or rise in wages will be a reaction to past economic conditions, not current let alone prospective economic conditions.

The June labour force report was from a survey taken late/May and early June reflecting employers’ decisions to employ taken even earlier. The next Q2 wage price index when released in mid-August will reflect the pressures in the market around May. The RBA has hiked the cash rate three times since early May and abandoned targeting the 3-year bond yield at 0.10% (a factor in the considerable lift in fixed rate mortgage interest rates over the past 6 months) back in November last year.

The effective monetary policy tightening that has occurred so far is dampening household demand, largely for housing so far. Leading indicators of consumer spending have been falling for several months, even though the most recent retail sales figures for May were still strong. It is worth noting that May retail sales were recorded before the second and third double-sized RBA rate hikes in June and July. In short, household demand, the mainstay of strong GDP growth in Q1 and probably Q2 as well is waning early in Q3. Waning demand strength in the economy will show in slackening demand for labour with a lag.

Returning to the earlier discussion about tight labour supply, if demand in the economy continues to pump higher at past strong pace, potential labour supply will struggle to keep pace. If as we suspect, however, demand is already weakening and is set to weaken further, prospective labour supply may prove adequate, perhaps even more than adequate, resulting in the unemployment rate starting to rise again at some point later next year.

There is still a case for the RBA to lift the cash rate further, but the labour force, wage and CPI readings over the next few months will provide a rear-vision view of over-heating pressure that is already showing signs of fading on more current assessment of household demand. There is a case for rate hikes to be less aggressive over the next few months.

Footnote: Author away on leave next week so the next economic report will be on Monday 1st August.