Cliff Notes: labour market strength to prove a key determinant of policy in 2023
Key insights from the week that was.
The strength of the Australian labour market was a key talking point this week as the unemployment and underemployment rates reached new multi-decade lows of 3.4% and 6.0% respectively.
Intriguingly, this occurred as the Australian economy lost 41k jobs and total hours worked declined 0.8%, offset by a 0.3ppt decline in participation. The ABS made clear that the loss of jobs in the month likely stemmed from the sample period coinciding with the winter school holidays; absences associated with COVID-19 and other illnesses; and flooding in NSW. Shifting seasonality also looks to have been a factor, with 35k jobs created on a non-seasonally-adjusted basis.
Not only is demand for labour strong, but the supply of labour remains heavily constrained (see below for a discussion of the latest migration data). Combined, these two trends look set to tighten Australia’s labour market further in coming months, with the unemployment rate forecast to fall to 3.0% around the turn of the year. While the headline Wage Price Index is yet to respond to this historic degree of labour market tightness (0.7%; 2.6%yr), the detail of the Q2 report make clear momentum is building. Most significantly, the private sector respondents that received a wage increase in the quarter reported a 3.8% gain, the strongest result since June 2012. We expect these gains to broaden across the population and to strengthen further through 2023, with annual growth in the headline wage price index forecast to peak at 4.5% at end-2023.
The potential risk that (extremely) limited spare capacity poses to Australia’s fight against inflation was evident in the RBA minutes for August, as discussed by Chief Economist Bill Evans. While global factors continue to be recognised for their role in the current inflationary episode, the August minutes gave “widespread upward pressures on prices from strong demand, a tight labour market and capacity constraints” greater attention. The Board also emphasised that strong demand conditions are expected to hold through 2022, potentially impacting inflation and expectations into 2023.
While cognisant of these risks, we continue to expect a peak cash rate of 3.35% at February 2023 will quell domestic inflation pressures as GDP growth abruptly slows to just 1.0%yr by December 2023. Before moving on from the RBA minutes, we also must highlight their discussion of climate change and the management of related risks. Specifically, climate change’s growing prominence in investor decision making was emphasised, as was the potential for these considerations to impact the cost of funding. Disclosure standards as well as the risks to the economy and financial system from climate change were also front of mind.
As noted above, migration data for July was also released this week. The recovery in overseas travel was supported by a return to mid-year seasonal strength as Australian residents and visitors embarked on short-term holiday travel. Arrivals and departures have now risen to be at 60% and 55% of their respective pre-pandemic levels, with a full recovery in these headline figures by the end of summer becoming increasingly likely. However, the clear lack of evidence indicating positive net inflows of temporary workers presents some offsetting concerns. This is not due to a lack of foreign demand for Australian temporary work, but rather the presence of substantial visa processing delays creating a notable lag in the return of temporary workers, offering little support to alleviate labour supply constraints within Australia.
Across in New Zealand, the resolve of the RBNZ to suppress inflation and associated risks was again on display at their August meeting, with another 50bp hike delivered and more flagged for later this year. As detailed by our New Zealand economics team, the decision statement focused heavily on inflation pressures and capacity constraints, most notably in the labour market. The expected pace of rate increases was also accelerated and the projected peak for the cash rate lifted slightly to 4.1%. Our New Zealand team broadly concur with the RBNZ’s thinking, having forecast two additional 50bp increases for the remainder of the year to a peak of 4.0%. However, they see more scope for interest rates to ease back in subsequent years given growing evidence that policy tightening is having the desired effect. Westpac’s August Economic Overview is now available for a full view of New Zealand’s economy.
Data received for the US this week was largely secondary in significance. July housing starts/ permits and existing home sales highlighted the shock to activity from tight financial conditions and declining real incomes, the latter materially impairing affordability. Retail sales meanwhile met expectations, but again showed a consumer challenged by the cost of living, with total sales flat in the month and core spending up modestly after a poor Q2.
The release of the week for the US was instead the FOMC’s July meeting minutes. Perhaps because the July meeting is between participant forecast updates, or potentially as they expect recent weakness to be recovered quickly, the tone of the Committee’s commentary was sanguine on activity and, in terms of the risks, still focused on inflation. That said, it seems as though expectations of risks are shifting. Inflation risks related to pandemic supply disruptions are seen as largely in the past, and “the apparent absence of a wage–price spiral” was noted – the latter minimising the risk of a third wave of inflation on strong consumer demand. Participants are also clearly of the view that “the bulk of the effects on real activity had yet to be felt” and so there is need to be cognisant of any change in activity momentum month to month. We remain of the view that September’s 50bp hike will be followed by two 25bp hikes in November and December to a peak fed funds rate of 3.375%. However, a pause to late-2023 will then be seen with 125bps of cuts to follow from December quarter 2023. This easing should support growth back to trend by end-2024 and see the unemployment rate stabilise around 5.0%, up from 3.5% currently.
In Europe, inflation continues to spark concern. In short, the Russia-Ukraine conflict and the COVID-19 reopening represent a dual-front of inflationary pressures. Supply issues continue to drive record inflation prints in the Euro Area (8.9%yr), with energy (39.6%yr) and food (11.5%yr) making particularly strong contributions. Simultaneously, the rebound in consumer spending across recreation, furniture and restaurants has materially broadened this pulse. Indeed, annual core inflation is not only double the ECB’s medium-term target at 4%yr, but a record 74% of the consumption basket is running at an annual inflation rate above 2.5%, well above the 10-20% range during the pre-pandemic era. Similarly in the UK, annual headline inflation has reached a double-digit pace of 10.1%, and a more concerning print for core inflation (6.2%yr) highlights the extent of the inflation challenge facing the region. Further monetary tightening is clearly warranted to fight this battle, even if a degree of weakness in activity materialises. Hence, we expect the ECB and the Bank of England to raise their respective key policy rates to 1.50% and 2.75% by year-end.
Coming back to China. The data received over the past week disappointed on every front. We are not anxious over the production environment, nor the outlook for infrastructure and business investment – even after the poor July credit outcome, year-to-date total social financing growth still sits at 15%, while comments by Premier Li this week made clear more support is coming. What is of concern though is the spread of COVID-19 in tourist areas such as Hainan. This outbreak has the potential to transmit the virus to multiple locations across the country, as holiday makers go home, and is also likely to deter other households from planning holidays and potentially increasing their discretionary services consumption closer to home. The limited progress in resolving the mortgage strike of recent months and with many developers remaining in a fragile state, it also seems likely that the recovery in housing investment will come later than we anticipated. As a result, we have revised down our 2022 growth forecast to 3.0% from 3.5%, but maintain a 7.0% projection for 2023. Authorities certainly have the capacity to deliver such an outcome, but co-ordinated action at both the central and local level will be required.
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