This chart will determine when the RBA starts hiking interest rates

Photo by Cameron Spencer/Getty Images

If you’re wondering what the Reserve Bank of Australia (RBA) will do next with official interest rates — be it to hike or cut, and when — you better familiarise yourself with the chart below.

Source: NAB

From the National Australia Bank’s (NAB) economics team, it shows the evolution in Australia’s unemployment and underemployment rates over the past 27 years.

In the NAB’s opinion, what happens next to these two line will largely determine not only the outlook for wage and inflationary pressures in Australia, but also which direction and when the official cash rate will move next.

“The pace and extent of the reduction in unemployment and underemployment, plus the progress of inflation back to the RBA’s 2%-3% target band, are key for when the RBA begins to normalise Australian interest rates,” the NAB says.

In comparison to Australia’s unemployment rate which has fallen in 2017, the nation’s underemployment rate — largely capturing those already in employment but who would like to work more hours — has continued to drift higher, contributing to lacklustre wage and inflationary pressures, and lower official interest rates, over the past few years.

According to the NAB, if those trends are to reverse a reduction in unemployment and underemployment must occur, something that should, if the economic textbooks are still correct, help to boost wage and inflationary pressures as the mismatch between labour supply and demand improves.

“A sustainable rise in wages and therefore core inflation is likely to require a reduction in unemployment and more importantly in underemployment as the latter has been elevated relative to unemployment in this cycle,” the bank says.

On that front the NAB thinks things are looking pretty good at present, noting that recent jobs data from the ABS points to a gradual reduction in labour market slack in the period ahead.

“Last week’s employment data reports employment growth of around 26,000 per month in trend terms. If sustained, this should be sufficient to reduce the unemployment rate across time, especially if population ageing reduces the participation rate a little each year as we suspect,” it says.

It also says that Australian consumer price inflation (CPI) data out this week will likely reveal that inflationary pressures in Australia have now bottomed, acknowledging that this will be “pleasing for the RBA.

However, while the NAB says that labour market conditions are likely to tighten further in the period ahead, it doesn’t believe it will be enough to boost wage and inflationary pressures by a sufficient amount to see the RBA hike rates this year, something it says will likely be reinforced by RBA governor Philip Lowe when he speaks later this week.

“This is… another opportunity to draw out the RBA’s assessment of how much slack there is in the labour market and hence the medium-term outlook for policy, wages and inflation,” it says.

“(Lowe) is likely to underline the importance of a reduction in unemployment and underemployment for the normalisation of Australian interest rates.”

The NAB says that RBA is only likely to consider hiking rates “when the unemployment rates is at 5.25% headed towards 5.0%”.

It currently stands well above the level nominated by the NAB at 5.6%.