Tight labour market puts Reserve Bank in a pickle

While unemployment eased slightly in May, the persistent strength of Australia’s labour market means that the Reserve Bank of Australia is unlikely to shake off its cautious approach ahead of its meeting next week, economists say.

Off the back of Australia’s latest jobs print, economists maintain that rate cuts from the Reserve Bank of Australia (RBA) are unlikely before 2025.

The seasonally adjusted unemployment rate fell to 4 per cent in May, a decline of 0.1 of a percentage point, according to the latest figures from the Australian Bureau of Statistics (ABS).

Employment rose by 39,700, higher than market forecasts of around 30,000, while the labour force participation rate remained unchanged at 66.8 per cent.

For market watchers, the latest data, against the backdrop of persistent inflation and low growth, paints a less-than-appealing case for the RBA to cut rates at its next meeting.

The RBA is slated to next meet on 17–18 June.

Paul Bloxham, HSBC chief economist, said the labour force figures “delivered few surprises” and the market remains relatively strong, although job creation has slowed a little over the course of 2024.

“Over the past six months, job creation has averaged 24,000 jobs a month, down from 35,000 a month in the six months prior. And, as largely expected, the loosening of the jobs market that has occurred has been mostly due to a boost to labour supply driven by strong inward migration and a high participation rate,” he said.

“This process is very gradually taking the heat out of the jobs market, which has seen most indicators suggest that wages growth is passing its peak. A smaller lift in the minimum wage than in previous years, 3.75 per cent as was announced on 3 June, adds to the case that wages growth is likely to have passed its peak.”

However, he noted, a key question remains whether the very gradual pace of loosening in the jobs market will be sufficient to slow wages growth or boost labour productivity, and in turn ease unit labour costs to a rate that is consistent with the RBA’s 2–3 per cent inflation target.

On 5 June, the ABS indicated the gross domestic product (GDP) in the March quarter delivered the slowest rate of annual growth in three decades, with GDP rising 0.1 per cent in the March quarter 2024 and 1.1 per cent since March 2023 (seasonally adjusted, chain volume measure).

A week prior, on 29 May, the ABS’ monthly CPI indicator print showed Australia still faces a sticky inflation challenge. The consumer price index (CPI) rose 3.6 per cent in the 12 months to April 2024, above the market expectation of 3.4 per cent.

“For the RBA, today’s jobs market print is unlikely to shift the dial,” Bloxham said.

“The central bank has a very shallow forecast rise in the unemployment rate as part of its own forecasts. Strong job creation while the labour market is gradually loosening due to boosted labour supply has been what the RBA was hoping for as part of its ‘narrow pathway’ to a soft landing.”

He forecasts the RBA to hold next week, and likely throughout 2024, with cuts beginning from the second quarter of 2025.

CreditorWatch’s chief economist, Anneke Thompson, said that the labour market remains very tight by historic standards.

“A continuing healthy labour market, as well as upcoming tax cuts, will make the RBA very cautious about cutting the cash rate too soon,” she said.

“It is likely that the RBA will wait until the full impacts of tax cuts flow through to retail trade, labour force and savings data, which won’t happen until late 2024 and into early 2025.”

Meanwhile, Russel Chesler, head of investments and capital markets at VanEck, described Australia’s persistent services inflation as “the monkey on Australia’s back” – a challenge only made more complicated by the strength of the labour market.

“With the unemployment rate falling to 4.0 per cent for May from 4.1 per cent in April, this solidifies our position that any reduction to the cash rate is a long way off. We don’t see a rate cut happening until 2025 – and possibly not until mid-year,” he said.

“The labour market remains relatively strong, with wage growth not expected to fall by much for the rest of this year.”

He pointed out the minimum wage increase announced in June effectively locks in entry-level wage growth for one in four workers either directly or indirectly, and “this may push up wages in the private sector as well”.

“Aggregate wages growth, which haven’t been supported by productivity gains, will remain above the RBA’s published target rate of 3.5 per cent, and we don’t see this changing in 2024,” Chesler said.

“Notwithstanding the rate cut movement happening in other developed markets, the RBA needs to see a sustained fall in inflation before it will cut rates. We’re mindful of [the] stage 3 tax cuts and other subsidies will start rolling out in just a couple of weeks, and this may lead to an increase [in] consumer spending, which will further delay the return to target inflation.”

However, offering a silver lining, State Street Global Advisors’ Asia-Pacific economist, Krishna Bhimavarapu, pointed out the labour market continued to cool faster than in previous cycles.

He said: “The annual growth in full-time non-seasonally adjusted employment (our preferred metric) is now 85.2 per cent down from its peak in October 2022, greater than the average fall (59.5 per cent) of the nine previous cycles.

“This should give the RBA some relief but may not swing their general assessment. However, GDP growth has been subdued, and the RBA will do well to take that into consideration during their policy discussion next week.”