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Will employment’s great run come to an end to tame inflation?

Australia’s unemployment rate remained stable in March at a low 3.5%, with the Participation Rate remaining strong at 66.7%. A very solid run of employment data is operating consistent with industry statements and anecdote: the Australian economy is at full employment and expansion is being curtailed by labour’s relative unavailability.

That could prove to be a short term issue however, because there is little doubt interest rate rises are starting to bite. It is classically held and has largely proved true that managing inflation via the demand sapping tool of interest rate rises, cools economies quickly, largely at the expense of employment levels.

In the binary land of economic commentary, the argument goes you can have low inflation or low unemployment but you cannot have both. Maybe that is true, but you can certainly have a balanced view of both inflation and unemployment.

The risk is that in chasing inflation down – the impact of interest rate rises always lags – the central bank overcooks interest rates, dragging demand down too far and tanking the economy, with marginal employment the big loser.

Time will tell if that is happening right now in Australia.

Meantime, the first chart shows the seasonally adjusted unemployment rate, which indicates the economy has been operating at full employment for at least the last six months, but probably longer.

There are plenty of indicators of a full employment economy. One of interest is the hours worked per month. March saw average work hours fall 0.2% compared with the prior month. However, hours worked are still well above the long-term average, at 88.77 hours worked per person, compared to the long term average of 85.74.

That is a fairly large difference actually, running at something close to 20 million hours more being worked per month by the same number of people than would be the case on average.

Although the RBA’s announcement of the May 2023 increase in the cash rate did not provide a direct link to the strength of the jobs market, this nevertheless indirectly influenced the decision. The RBA media release commented that:

The recent Australian data also confirmed that the labour market remains very tight, with the unemployment rate at a near 50-year low. Many firms continue to experience difficulty hiring workers, although there has been some easing in labour shortages and the number of vacancies has declined a little. … Significantly given the expected below trend growth in the economy unemployment rate is forecast to increase gradually to around 4.5% in mid-2025.

So, the RBA is effectively confirming it will sacrifice some employment in the economy to bring inflation into control.

That is one consideration, but in an environment where many businesses are seeking additional labour, it could make you wonder how deep a downturn we might be looking at over the next year and thereafter.

On the back of these strong employment numbers, there were a number of commentators who predicted a return to interest rate increases in May. They were proved correct, which operates as further evidence of the intent of the RBA.

That can only really mean that further increases maybe expected unless and until people start losing their jobs.

Fun times!

Posted Date: May 8, 2023

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