Australia's historically low unemployment rate, touted as one of outgoing Reserve Bank of Australia governor Philip Lowe's notable achievements, could present challenges for his successor, Michele Bullock.
Despite the central bank's efforts to increase interest rates over the past thirteen months, the unemployment rate remains near a 50-year low of 3.5 percent, only marginally higher than the record low of 3.4 percent achieved through unprecedented fiscal and monetary stimulus during the pandemic.
"Thirteen months after the central bank began its fastest interest rate increase in three decades, the unemployment rate remains near 3.5 percent," stated Warwick McKibbin, former RBA board member. "That means we're likely to see prices falling in Australia if we do nothing with monetary [policy]."
Since the rate hikes began, the unemployment rate has decreased by nearly 0.5 percent, surpassing the RBA's most recent forecast of 3.6 percent for the June quarter. "Jobs growth of 33,000 in the previous month was well above the RBA's forecast of 2.5 percent," said McKibbin.
Inflation, on the other hand, has experienced a rapid decline from a 30-year high of 7.8 percent in the December quarter, mainly due to cooling energy prices, diminishing pandemic effects, and rising interest rates. "June quarter CPI data next Wednesday are expected to show inflation fell to 6.2 percent," McKibbin added.
Should inflation remain below the RBA's forecasts of 6.25 percent for headline CPI and 6 percent for trimmed mean CPI, confidence would grow that inflation will eventually reach the upper end of the 2-3 percent target range by mid-2025, potentially leading to a steady interest rate decision. However, the data are also expected to underscore that core inflation remains significantly above the top of the RBA's target range and is unlikely to return within the band anytime soon.
Moreover, an extremely tight labour market and the recent large increase in award wage rates increase the risk of a price-wage spiral that could force the RBA to lift rates more than expected.
"The central bank's inflation forecasts are partly based on its expectations that the unemployment rate will rise to 4 percent by end-2023 and 4.5 percent by end-2024," said Capital Economics. However, current data indicate that the unemployment rate will likely remain well below 4.5 percent.
"If unemployment remained too low for too long, inflation expectations would rise, which would make it harder for the monetary authorities to bring inflation back down," warned Michele Bullock, the incoming RBA governor.
The strength of the labour market was also reflected in a 0.5 percent rise in hours worked. "The productivity crunch will only add to the RBA's ongoing concern that surging unit labour cost growth could lead to stickier inflation than it currently anticipates," added Abhijit Surya, economist at Capital Economics.
Explaining the RBA's decision to not lift interest rates this month, the minutes of its board meeting noted that higher interest rates "could also be expected to encourage households to save more, which would affect consumption" and "if that were to occur, the demand for labour would slow and the unemployment rate would be likely to rise beyond the rate required to ensure inflation returns to target in a reasonable time frame."
While leading indicators suggest a mild softening in the labour market over the coming months, retail sales, business surveys, and jobs data present an upside risk to forecasts for household income and inflation, potentially impacting the outlook for the RBA's cash rate peak of 4.35 percent, according to UBS chief economist George Tharenou.
As Michele Bullock assumes the role of RBA governor, she faces the challenge of managing a tight labour market that could stoke inflationary pressures and necessitate careful policy decisions to maintain price stability in Australia's economy.
