- Australian employment increased by over 300,000 in the 12 months to March this year.
- Strong hiring has helped to keep Australia’s unemployment rate near the lowest level in eight years.
- Continued strength in employment contrasts with other indicators such as GDP and inflation, which have weakened noticeably in recent quarters, creating uncertainty as to the true strength of the economy.
- To help resolve this uncertainty, the RBA is paying “close attention to developments in the labour market”.
- Economists at J.P. Morgan and Westpac believe this uncertainty will be resolved by an expected increase in unemployment in the months ahead. Both are forecasting that the RBA will cut Australia’s cash rate by 25 basis points in August and November, leaving it at a new record low of 1%.
Despite the abrupt slowdown in the Australian economy in the second half last year, hiring has remained strong, an outcome that has kept Australian unemployment sitting near the lowest levels in eight years.
That, to this point at least, has also seen policymakers at the Reserve Bank of Australia (RBA) hold off cutting official interest rates despite data showing inflationary pressures weakened further in the first three months of the year.
It’s an unusual situation.
On the one hand, recent GDP and inflation data suggests the economy has lost considerable momentum. But on the other, official labour market data suggests activity levels are pretty good.
Why would employment growth remain strong if the economy is struggling, right?
The RBA, based on recent remarks, is waiting for the “tension” between the labour market and other economic indicators, as it has described it, to be resolved before deciding whether or not to cut official interest rates, acknowledging earlier this month that it will be paying “close attention to developments in the labour market at its upcoming meetings”.
According to new analysis from J.P. Morgan, the RBA won’t have to wait long to uncover which economic indicator — the labour market or GDP — is currently providing the best signal of the true strength in the economy.
“We expect the Australian labor market to deteriorate in coming months and the unemployment rate to finish the year in the mid-5% [region], said Tom Kennedy, economist at J.P. Morgan, in a research note released last week.
“We base this forecast on a combination our view that real GDP will remain sub-trend in 2019 and therefore below levels required to generate sufficient jobs growth and the recent softening across the leading labor indicators, which continue to signal a steady rise in unemployment.”
Trend growth is the level at which the economy grows sufficiently to keep inflation and unemployment stable. Many regard trend growth in Australia to be around 2.75% per annum.
The chart below Kennedy shows changes in Australia’s unemployment rate, as calculated by the ABS, overlaid against what J.P. Morgan’s Australian unemployment model, based upon a variety of leading labour market indicators, suggests will happen in the months ahead.
With Australia’s economic growth expected to remain sluggish, and most leading labour market indicators also starting to weaken, J.P. Morgan believes Australia’s unemployment rate will begin to trend higher in the months ahead, paving the way for a likely reduction in Australia’s cash rate given persistent weakness in inflationary pressures.
In its May monetary policy statement, the RBA said that a “further improvement in the labour market was likely to be needed for inflation to be consistent with [the bank’s] target”.
Helping to underpin J.P. Morgan’s views on the outlook for unemployment and GDP, Kennedy says that while total employment growth has remained firm in early 2019, increasing by over 300,000 in the year to March 2019, according to official data from the ABS, that’s masked some fairly weak results from some key sectors in the economy.
“The current mix of employment growth is interesting given that sectors we have previously identified as bellwethers for overall labor market slack and cyclical momentum — namely construction, manufacturing, retail, real estate, and administration — are among the worst performers,” Kennedy said.
“The retail, construction, and manufacturing sectors have all recorded meaningful job losses in the past year, totaling 140,000.
“Job creation in the real estate and administration sectors has been similarly unimpressive and in net terms ranks in the bottom half of the industry employment distribution.”
According to Kennedy, more often than not, where hiring in bellwether sectors goes, domestic demand in the Australian economy tends to follow.
While the two have disconnected recently, Kennedy doesn’t expect the divergence to last, warning the current mix of employment growth is “consistent with the deterioration in the leading [labour] indicators and aligning with our view that the jobless rate is poised to drift modestly higher in coming months”.
“Viewed in conjunction with recent weakness in GDP and core inflation, we think this is enough to warrant a policy response and look for rate cuts in August and November,” Kennedy said.
The view expressed by J.P. Morgan is similar to analysis from Westpac last month which found hiring in cyclical sectors of the economy — including some of the largest employers nationally such as construction and retail — has weakened noticeably over the past 12 months, masked by continued strength in non-cyclical areas and in professional services.
“Non-cyclical jobs — dominated by government — have been strong and this sector is increasing as a proportion of total employment,” said Bill Evans, Chief Economist at Westpac, in a research note released in mid-April.
“Cyclical sectors are slowing markedly and are falling as a proportion of total employment. Given the lags and the cautious outlook for growth, employment in these sectors is likely to continue to slow.”
Westpac defines cyclical sectors as construction, manufacturing, retail and wholesale trade, accommodation, transport, finance, mining, real estate, recreation, and media. It deems “non-cyclical” sectors to be public administration, education and training, health care and utilities.”
According to Westpac, in the six months to February this year, employment growth in cyclical sectors fell at an annualised pace of 0.4%.
Over the same period, hiring in non-cyclical sectors rose by 5.6% in annualised terms, and by an even faster 7.9% pace in professional services.
“Strong government spending in the infrastructure space is likely to explain a considerable part of the success of [professional services],” Westpac chief economist Bill Evans said. “The sharp lift in government regulations is also supporting this sector.”
While strong hiring in government and government-linked areas has helped to keep annual employment growth rollicking along at over 2% per annum, Westpac, like J.P. Morgan, says weak hiring in cyclical sectors, coupled with an expectation that GDP growth will remain sluggish, will eventually see unemployment “drift up” to 5.4% in the second half of the year, paving the way for the RBA to cut official interest rates in the months ahead.
“Our analysis points to a marked slowdown in jobs growth already being well underway in the cyclical sectors of the economy,” he said.
“We expect that eventual recognition of these facts will keep the RBA on track for our expected first rate cut in August.”
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