RBA: Australian unemployment may have reached its peak, and interest rates their bottom

Australia’s unemployment rate may be close to its peak, creating implications for the economy, and as a consequence, interest rates according to RBA assistant governor Christopher Kent in a speech delivered in Brisbane earlier today.

Kent noted there may be “slightly less spare capacity in the labour market than earlier anticipated”, adding it had “been adjusting more smoothly over the past year than we had been expecting”. His comments are in line with updated forecasts by the RBA in its quarterly statement on monetary policy last Friday.

Spare capacity, or labour market slack, refers to the availability of workers within Australia’s labour market.

Kent’s speech attempts to offer an explanation of why the bank previously overstate the slack, and why it’s now probably lower than they first thought, pointing to factors such as a slowdown in population growth, slower wage growth and a compositional change in economic activity of late.

Here’s Kent on the first factor – slower population growth.

“As recently as May, official data suggested that the working-age population had been growing by about 1.7% per annum, and it was expected to continue at about that rate in the foreseeable future. However, the most recent data from the ABS suggest that total population growth had dropped quite noticeably over the past year or so, from 1.8% over 2012 to 1.4% over 2014. Estimates of the working-age population are expected to be revised down accordingly in coming months”.

The chief reason for this downward revision was slower immigration, something Kent believes is due to “to the weakening in Australia’s labour market conditions relative to those of other countries”.

He noted that “the unexpected slowdown in population growth implies somewhat less rapid growth of our labour force than otherwise”.

As a consequence, and importantly in terms of the future pathway for monetary policy, he believes “that the GDP growth that we have recorded may have been closer to the recent growth in the economy’s productive capacity than previously thought”.

In other words, the below-trend economic growth seen in recent years may actually be trend, or the “new normal”, to borrow a well-worn phrase.

If Australia’s economy is now growing at a “new normal” trend rate, it points to steady unemployment levels and potentially steady monetary policy, not interest rate cuts.

Beyond the slowdown in growth in working age population, Kent suggested that the “very low” growth in labour costs may also have helped prop up employment despite subdued levels of economic growth.

“Wage flexibility has assisted with the labour market adjustment” said Kent, adding “low wage growth across the economy has enabled firms to employ more labour than would otherwise have been the case”.

The third factor Kent suggests may have diminished labour market slack is a compositional change in economic activity.

Despite weak levels, largely as a result of the winding down of the mining CAPEX boom, conditions across services industries improved substantially according to recent business surveys.

Kent points out that growth in “consumption, dwelling investment and net service exports have increased over the past year even though GDP growth has eased back a touch in year-ended terms”.

This improvement across non-mining sectors of the economy “may may have underpinned a rise in the demand for labour of late”, according to Kent.

“In order to satisfy increased demand for services, firms in those sectors have hired more workers”, he said.

He also attempted to explain the divergence between recent labour market hiring and business spending intentions, noting that “the service sectors, on average, have relatively low capital-to-labour ratios compared to those producing or distributing goods”.

That is, the services sector doesn’t have as greater need to invest in capital equipment, building and structures than others such as mining and manufacturing.

So there we have it. Slower population growth, low wage growth and a compositional switch in the drivers of Australian economic activity have been working in tandem to reduce labour market slack.

While are similar to the ideas floated by RBA governor Glenn Stevens a few weeks ago when he attempted to explain why Australia’s unemployment rate has stabilised, Kent’s speech appears to be more about fact than hypothesis.

This suggests that the RBA believes Australia’s economy is perhaps running close to, or at trend, explaining the steady rate of unemployment (in trend terms at least).

If correct it puts the likelihood of further interest rate cuts from the board, at least on this logic, squarely in doubt.

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