Australia’s unemployment rate fell to 5.6% in September, leaving it at the lowest level seen since February 2013.
On face value it’s good news. Coupled with above-trend economic growth and a 1.4% increase in employment over the past 12 months, it suggests that labour market conditions are strengthening.
However, according to James McIntyre and Philip Naylor, analysts at Macquarie Securities, the trend in jobs growth and the unemployment rate trend are misleading when gauging the true strength of the labour market right now.
“We have dug deeper into the labour market to try and bridge the gap,” said the pair.
“Strong GDP growth is not delivering growth in demand for labour. And weak labour demand is being masked by a combination of weak participation, and reductions in hours worked.
“As a result, the usual rule of thumb — the unemployment rate — is proving an unreliable guide to wage pressures, and policy,” they say.
This chart from Macquarie goes some way to explaining what McIntyre and Naylor are talking about.
It shows Australia’s trend unemployment rate in black, overlaid against what it would be if labour force participation and hours worked remained constant from the levels seen at the start of 2016.
As it shows, while the official rate has been edging lower, this has been due to less people of working age participating in the labour market and a decline in total hours worked.
“In trend terms, hours worked across the economy have fallen 0.4% since the end of 2015. But the number of employed Australians has still grown,” says McIntyre and Naylor.
“We estimate that 20 minutes has been cut from the average Australian work week since the end of 2015. If this hadn’t occurred, then employment would instead be 124,000 lower, and the unemployment rate one percentage point higher.”
Since the beginning of the year, Australia’s trend participation rate has fallen from 65.1% to 64.7%, further helping to lower the official unemployment rate as those who could work choose not to.
According to McIntyre and Naylor, this suggests that “Australia’s labour market has been accumulating a significant degree of slack, despite apparent strength in headline GDP growth and a slow and steady grind lower in the unemployment rate”.
Other measures of labour market slack, including Australia’s underemployment and underutlisation rates, reflect this view, pushing higher this year even as the unemployment rate fell.
Macquarie believes this trend will continue in the period ahead, keeping a lid on wage growth and inflationary pressures and adding pressure on the RBA to cut interest rates further.
“We think the Australian economy’s combination of firm population growth and labour-lite GDP growth is set to continue,” they say.
“For the RBA, the growth composition is likely to see further disinflation, which we think will precipitate additional rate cuts in 2017.”
Macquarie is forecasting two further 25 basis point rate cuts from the RBA in the first half of 2017.
The view conveyed by McIntyre and Naylor is supported by Gareth Aird, senior economist at the Commonwealth Bank.
In a research note released late last week, he said that soft labour market conditions in Australia won’t be enough to push inflation higher due to weak wages growth, pointing to the likelihood that 1.5% will not mark the terminal level for interest rates.
“The unemployment rate may fall further, but other measures of spare capacity and labour demand suggest there will be little in the way of wage inflation to feed into consumer inflation,” says Aird.
“As such, we think 1.5% won’t be the bottom of the cash rate cycle. And we think that current market pricing, which puts the terminal rate at 1.4%, is underestimating the chance of more policy easing.”
The ABS will release Australia’s October jobs report on November 17. Arriving a day earlier, it will also release Australia’s Q3 wage price index, a report that has now taken on even more significance than usual.