Why no one's really excited by the recent fall in Australian unemployment

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  • Australian unemployment tumbled to 5.4% in May, moving it closer to the level where some estimate that wage pressures will begin to build.
  • Despite the fall in unemployment, pessimism about the outlook for wage growth remains entrenched given broader indicators on labour market slack didn’t improve in early 2018.
  • Labour market underutilisation, rather than unemployment, has a stronger relationship with wage pressures in recent years.

Australian unemployment tumbled in May, falling to 5.4%, the lowest level since November last year.

While the decline largely reflects that more Australians left the labour market than entered, rather than an acceleration in jobs growth, it took the unemployment rate back towards the 5% level where many, including the Reserve Bank of Australia (RBA), estimate that wage pressures will build.

The RBA estimates that Australia’s full employment rate, or the non-accelerating inflation rate of unemployment (NAIRU), currently sits around 5%, although it admits that it could be lower given the evidence seen abroad in recent years.

However, despite what was seemingly good news on the outlook for wage growth, economists and financial markets weren’t all that impressed — a somewhat unusual reaction given how important wage growth is in determining the outlook for household spending, economic growth, inflation and official interest rates.

Rather than suggesting that Australia is moving closer towards an acceleration in wage growth, many economists suggested that such a scenario may have moved even further away.

A major reason behind this renewed pessimism was that broader indicators of labour market slack didn’t decline in the three months to May.

Australia’s labour force underemployment rate — measuring those workers with a job but who would like to work more hours — increased by 0.1 percentage points to 8.5% in seasonally adjusted terms.

Combined with unemployed workers, that left Australia’s underutilisation rate steady at 13.9%.

As seen in the chart below from Deutsche Bank, the lack of progress in reducing the proportion of underutilised workers has ramifications for wage pressures.

Deutsche Bank

It shows to constructs of Australia’s Phillips curve, looking at the relationship between labour market slack and annual growth in Australia’s quarterly wage price index.

Using the unemployment rate, shown in red, the relationship between it and wage growth has weakened significantly in recent years. The red dots down the bottom reflect recent wage and unemployment outcomes.

However, when compared to labour market underutilisation, the relationship is much stronger with annual wage growth, hinting that changes in underutilisation, rather than unemployment, is more influential in determining wage pressures.

As seen in the next chart, underutilisation remains elevated in Australia, helping to explain why many workers are seeing no real wage growth after inflation is taken into consideration.

While there are other factors that have contributed to recent wage outcomes, until underutilisation is reduced, it’s unlikely that we’ll see an acceleration anytime soon.

Many suspect that Australian economic growth will have to remain above trend — currently deemed to be around 2.75% per annum — for a substantial period of time in order to reduce underutilisation levels.

The RBA thinks that will happen but not everyone is as optimistic, helping to explain the ongoing pessimism regarding to outlook for employee wages.

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