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Sunday, 7 May 2017

Australian unemployment rate left in the dirt

Australia the laggard

The US unemployment rate continued to fall to just 4.4 per cent in April.

Closer to home, New Zealand's unemployment rate was revised down for the December 2016 quarter, and fell to just 4.9 per cent at the end of the first quarter of 2017.

That's the same New Zealand that saw its third largest city and the most populous city on the south island razed by earthquakes, so it's been an impressive recovery for the "rockstar economy".

Heck, even in the beleaguered UK with all of its referendum uncertainties the unemployment rate fell to 4.8 per cent late last year and has remained there in 2017, while acknowledging Britain's slightly different reporting standard.

There's some pretty compelling evidence here - at least, one would think! - that stimulatory policies have come up with the goods. 

Down Under, meanwhile, the unemployment rate has cut itself adrift and has risen to 5.9 per cent, and the Reserve Bank of Australia (RBA) now expects the unemployment rate to remain above 5.5 per until 2019. 

And with more work than ever being part time or contractual in nature, nominal wages growth in Australia is at record lows, while underemployment is at record highs.

It is true that New Zealand has less geographical heterogeneity to deal with than Australia. In fact, the Aussie economy has long been a dichotomy, with the resources states moving in markedly different cycles from Sydney and Melbourne.

In Greater Perth the labour market has deteriorated from full employment to notch an unemployment rate of above 7 per cent, while in Greater Adelaide a multitude of challenges have led to an unemployment rate that is higher still. 

Despite the challenges of diversity, so much slack in the labour force after all this time can only be seen as a disappointing result.

It should be noted that the RBA is much more upbeat in its forecasts, forecasting stronger growth to return to the economy (3.3 per cent annualised for the first half of 2018!), partly assisted by post-Cyclone rebuilding in Queensland.

If this plays out then the RBA will be hiking some time in 2018, but markets appear to think this is optimistic... 

Inflation to weaken again?

The RBA has clearly been a reluctant cutter, and the core inflation rate has been consistently undershooting the 2 to 3 per cent target range for some time now.

While I appreciate the counter-arguments and could be accused of spending too much time with my nose in the dusty textbooks, central bank credibility should be reflected in a commitment to a clearly defined policy goals.

There is arguably a risk that the longer the inflation rate deviates from the target, the more people believe that the RBA doesn't care about undershooting, and the stable nominal anchor is lost (this certainly appears to be happening, based on recent media pieces).

The latest Statement in Monetary Policy (SOMP) shows the mid-point of inflation forecasts meandering back to 2 per cent eventually, but not until well into 2019, arguably creating an unnecessary output gap.

The gaping width of the confidence intervals as they fan outwards say something about how easy it is to forecast inflation, of course.

But with the iron ore price crashing down at an alarming pace, the oil price gapping through support last week, and coal spot prices likely to head lower as the year progresses, there appears to be a likelihood that inflation will continue to undershoot the target for even longer than it already has. 

A further complicating factor that could create more downward pressure on the outlook for inflation in the December 2017 quarter is the re-weighing of expenditure classes.

Source: RBA

There are already disinflationary price pressures evident at the supermarket shelves and in the clothing and footwear sector. And the RBA notes that this could now be spreading into other retail items such as furniture and household appliances, not least because of increased competition from foreign retailers.

Apartment construction drag (and the "P&I cliff")

As if all that wasn't enough, tomorrow's building approvals figures will likely confirm that the peak of the residential construction boom is also firmly in the rear view mirror, with year-on-year approvals likely to be well down from more than the seasonally adjusted result of more than 20,200 in March 2016.

This is another point where RBA growth forecasts are arguably too optimistic, expecting residential construction to continue contributing to growth throughout the first half of 2018.

More than 1.1 million Australians are already employed in construction - an extraordinarily high number for a workforce of a bit more than 12 million - and about three quarters of these employees are in the residential sector.

In my opinion, while there self-evidently remains a huge number of dwelling units under construction, particularly apartments, the actual level of construction activity is set to slow imminently, potentially undermining growth forecasts. 

While fears of a "P&I cliff" - as borrowers are ultimately forced to repay principal on interest-only debt - may be overblown, APRA's interventionary measures will gradually strangle the investor sector of the market, while the regulator's guidelines insisting on proving serviceability at 7.25 per cent will also cap growth in the average mortgage size. 

For reasons that I can't readily explain, lots of the media talk has been about interest rates being hiked already, despite inflation remaining below the target range.

For the record, futures markets don't agree with the dovish themes of this post! The yield curve remains moderately inverted, but implied yields on cash rate futures suggest that rates will likely remain on hold this year and next.