The Australian labour market

 

Matthew Peter, Chief Economist

 

Next week, we receive the latest snapshot of the health of the Australian jobs market, when the Australian Bureau of Statistics releases March labour market data. In addition to job growth, the data also includes estimates of the unemployment rate and the labour force participation rate. The labour market data are critical to the assessment of the economy as employment growth is at the heart of economic activity and spending, the participation rate tells us about changes to the potential pool of workers available to the economy, while movements in the unemployment rate are harbingers of wage gains or losses and, hence, of inflationary or disinflationary pressures.

 

For these reasons, labour market data are closely followed by markets and policy makers alike. In particular, the Reserve Bank of Australia is on the lookout for signs that a tightening/easing labour market, resulting in a falling/rising unemployment rate could foretell faster/slower wage growth and inflation. Employment growth has recovered spectacularly since its November 2016 low point of sub 1% annual growth in the wake of Brexit and the fear of a Donald Trump administration in the White House. Since then, employment growth has climbed steadily to reach a recent high point of 3.5% annual growth in February; its highest rate of growth in well over a decade.

 

Notwithstanding the fast growth in employment, the unemployment rate has remained stubbornly sticky, declining by only 20 basis points (bps) from its November 2016 level of 5.8% to its February 2018 level of 5.6%. Consistent with the small drop in the unemployment rate, annual wage growth has barely improved from its 2016 December quarter low point of 1.9% to its 2017 December quarter rate of 2.1%. How worried should we be about the lack of improvement in the rates of unemployment and wage growth? Let’s tackle the unemployment rate first. The small decline in the unemployment rate, despite such a strong pick-up in employment, is due to the sharp rise in the labour force participation rate, which has risen from 64.7% in November 2016 to 65.7% in February 2018. Had the participation rate remained at its November 2016 level, and had the economy experienced the same pick-up in employment growth from November 2016 to February 2018, the unemployment rate would be 4.2%; 80bps below the accepted level of the NAIRU, rather than 60bps above NAIRU, as it currently stands.

 

The rise in the participation rate is typically a healthy sign that people previously discouraged from seeking employment are, instead, deciding to enter the workforce. Over the last 16 months, it has been a strong uplift in the female participation rate from 59.3% to 60.6% that has largely been responsible for the increase in the Australian labour force participation rate. If we assume the same relationship between the unemployment rate and wage growth that has occurred over the last 16 months and apply it to an unemployment rate of 4.2% rather than the actual current level of the unemployment rate of 5.6%, then wage growth would currently be running at an annual rate of 3.5% rather than 2.1%. Leaving aside the heroic nature of our assumption of the (linear) relationship between the unemployment rate and wage growth over a period as short as 16 months, it is unlikely that employment growth of the rate we have seen over 2017 and the first months of 2018 would have been sustained had wage growth risen sharply.

 

Our long-held view has been that the Australian economy requires a sustained period of modest wage growth, in order to help restore international competitiveness eroded during the decade of Australia’s mining boom (from 2002 to 2012). This period saw Australia’s unit labour costs outstrip those of the US by 25% and those of the euro area (the perennial laggards of labour market efficiency) by 20%. If we combine the rise in labour costs with the rise in the Australian dollar of around 100% during the mining-boom decade, we get a deterioration in international competitiveness of the Australian economy of around 125%. Since the end of the mining boom, the Australian economy has retrieved some of this lost competitiveness. The Australian dollar has retraced by around 30% and unit labour costs have underperformed their US and euro area counterparts by around 10% against the US and 5% against the euro area. The good news is that, despite the decline of Australia’s terms of trade from its level during the halcyon days of 2011, the prices of iron ore, metallurgical coal and gas (our major bulk commodity exports) are unlikely to retrace to their pre-2002 levels, meaning that our wealth (and therefore the ability of the economy to pay a higher level of wage) is permanently higher than it would have been. The higher terms of trade is reflected in a higher sustainable level of the exchange rate, which we view as being around US$0.72 cf US$0.65 before the mining boom.

 

The other good news for Australia is that tight labour markets and resurgent wage growth abroad is helping Australia restore competitiveness and alleviating the need for ongoing wage suppression in the domestic labour market. Currently, US wages are growing at an annual rate of 2.7% and gradually trending higher. Unfortunately, a gap of just 60bps in wage growth leaves little scope for a shift higher in Australian wage growth if we are to continue with an improvement in international competitiveness. In our view, wage growth will remain modest for some time to come. So, what will the March labour market statistics reveal next week? Our forecasts are for a continuation of robust employment growth with an addition of 20K jobs over March, which will see the unemployment rate edge lower to 5.5% with the participation rate plateauing at 65.6%.

 

Table 1: Financial market movements, 5– 12 April 2018

Equity index

Level

Change

10-yr government bond

Yield

Change

Foreign exchange

Rate

Change

S&P 500

2,664.0

0.0%

US

2.84%

0.4 bps

US Dollar Index (DXY)

89.75

-0.8%

Nikkei 225

21,660.3

0.1%

Japan

0.04%

-0.9 bps

USD-JPY

107.33

-0.1%

FTSE 100

7,258.3

0.8%

UK

1.46%

3.8 bps

GBP-USD

1.423

1.6%

DAX

12,415.0

0.9%

Germany

0.52%

-0.9 bps

EUR-USD

1.233

0.7%

S&P/ASX 200

5,815.5

0.5%

Australia

2.66%

-0.2 bps

AUD-USD

0.775

0.9%

Source: Bloomberg

 

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