Recent Australian jobs data has been very encouraging, especially compared to the signals seen throughout much of 2016.
Over the past 12 months, employment has increased by 240,200 in seasonally adjusted terms, the fastest pace of hiring since January last year. And most of those jobs have been full-time roles, increasing by 175,400 over that period, leading to a sharp acceleration in the total number of hours worked.
With hiring levels humming along, Australia’s unemployment rate has also been edging lower, falling from close to 6% earlier this year to 5.6% in June.
It all points to an economy that is eating up existing labour market slack, a development that has got some excited about the prospect of a rebound in wage growth, and with it an increase in inflationary pressures and official interest rates.
While the unemployment rate still sits well above the 5% level the Reserve Bank of Australia (RBA) deems to be Australia’s non-accelerating inflation rate of unemployment (NAIRU) — the level where the unemployment falls to a sufficient level to stir wage and inflationary pressures — such has been the scale of the recent improvement in Australia’s jobs data that some believe the RBA could lift interest rates as soon as November this year.
Although some believe that’s a plausible outcome, the vast majority do not. And that includes economists at Westpac.
The bank says that while there’s been a material strengthening in employment growth in recent months, which along with a reduction in the unemployment rate suggests labour market conditions are tightening, it’s not the unemployment rate, but rather Australia’s underemployment rate, that markets should be focused on in terms of assessing when the RBA is likely to hike rates.
Underemployment measure the number of people who are employed but who would like to work more hours, and, as seen in the chart below, it has continued trend higher over the past year even as unemployment has fallen.
To Westpac, this is far more important in terms of when the RBA will lift interest rates.
“Underemployment has continued to trend higher, signalling a much greater degree of labour market slack than the unemployment rate implies,” the bank says, adding “data available for wages is more consistent with underemployment rather than unemployment.”
That suggests that despite recent declines in the unemployment rate due to an acceleration in job creation, there’s still an abundance of labour available to suffice existing demand from firms, keeping a lid on wage growth as a consequence.
And while some clearly feel that the mismatch between labour supply and demand will lessen in the period ahead, helping to boost the prospects for higher wage growth, inflationary pressures and higher interest rates, Westpac says there’s plenty of evidence to suggest that this may be easier said than done, noting that even in states where economic and employment growth has been strong in recent years there’s been few signs of a rebound in wages.
“While perhaps unsurprising in a state like Western Australia or even Queensland, this phenomenon is also being seen in the states which have experienced the strongest activity and employment growth, Victoria and New South Wales,” it says.
“This implies that the weakness in wages is entrenched and will be difficult to remedy.”
Entrenched and difficult to remedy. Yes, not the best of news for those eagerly anticipating a big pay increase at your next review.
This chart helps to explain why Westpac remains downbeat on the prospect for a rebound in wages.
It shows the relationship between labour market underutilisation levels — combining both unemployed and underemployed workers — compared to annual wage growth for private-sector workers in Victoria.
Despite seemingly strong economic conditions in Victoria over the past couple of years, private wage growth has been held back by elevated levels of labour market underutilisation.
And that’s in the state where economic conditions have been far stronger than most, underlining the challenge facing policymakers in helping to boost wage growth across the broader Australian economy in the period ahead.
That goes someway to explaining why Westpac, in comparison to some more optimistic forecasters, says that the RBA is likely to leave official interest rates unchanged until at least the end of 2018.
In it’s opinion, if existing labour market slack is to fall to a level where wage and inflationary pressures start to build, it require a strong rebound in Australian economic growth.
“Above trend growth in the economy and sustained robust job creation is necessary to produce a material improvement in wages growth,” it says, adding the warning that “this is not an expectation that we hold”.
And Westpac is not alone in that view.
According to the National Australia Bank’s (NAB) Australian economics team, progress on reducing Australia’s underemployment rate will be crucial in determining when and if the RBA chooses to hike rates.
“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,” it said in a note released this week.
The NAB says that RBA is only likely to consider hiking rates “when the unemployment rates is at 5.25% headed towards 5.0%”.
Like Westpac, the NAB doesn’t see the RBA lifting official interest rates until at least the fourth quarter of 2018.