MNI ANALYSIS: Labor Mkt Key Test to RBA Steady Rate Patience

--Labor Data To Be Single-Most Important Driver of RBA Policy

--Household, Business Sentiment Disconnect Also Important For Policy

By Sophia Rodrigues

     SYDNEY (MNI) - Patience has been the cornerstone of the Reserve Bank of

Australia's monetary policy stance for nearly a year and the outlook for policy

will depend on whether the labor market puts that patience to test in coming

months.

     The monthly labor force survey published by the Australian Bureau of

Statistics is therefore likely to be the single most important set of data

driving monetary policy. Other data on the exchange rate, wage growth,

inflation, retail trade and the housing market will continue to be important but

mostly as either a driver or consequence of developments in the labor market.

     Earlier this month, Governor Philip Lowe admitted the RBA has been

deliberately patient with monetary policy -- resisting a cut in the cash rate to

cause a faster rise in inflation -- and instead focusing on risks from high

household debt. Key to that patience has been the improvement in the labor

market seen so far this year.

     "Since August last year, the Reserve Bank Board has held the cash rate

steady at 1.5%. This setting of monetary policy is supporting employment growth

and a return of inflation to around its average rate of the past couple of

decades," Lowe said in his opening statement at the Parliamentary testimony on

August 11.

     "The Board is seeking to do this in a way that does not add to the

medium-term balance-sheet risks facing the economy," he continued. "It has been

conscious that a balance needs to be struck between the benefits of monetary

stimulus and the medium-term risks associated with rising levels of debt

relative to our incomes."

     "As a result, the Board has been prepared to be patient. The fact that the

unemployment rate has been broadly steady has allowed us this patience. We have

preferred a prudent approach, which is most likely to promote both macroeconomic

and financial stability consistent with the medium-term inflation target," he

said.

     The improvement in the labor market is key because of the impact it would

have on household income growth. That income growth is important not just for

household spending, and thus growth in the economy, but also because of the

favorable impact it would have on the household debt-to-income ratio -- the

latter of which has been the RBA's main area of concern in the past year.

     The unemployment rate has inched down to 5.6% in July from 5.7% in August

last year. The drop is small but it masks a significant improvement in the labor

market in that period. The employment-to-population ratio increased to 61.5%

from 61.0%. The number of employed grew around 252,000 due mainly to a 196,000

rise in full-time jobs, while the number of unemployed rose just 14,000 as the

participation rate rose to 65.1% from 64.7%.

     The rise in mainly full-time employment has meant there has been a growth

in overall income even though wage growth rate has been subdued at record lows

of 1.9% y/y.

     This growth in income and the gradual removal of spare capacity through the

rise in employment has allowed the RBA the luxury of patience. 

     The RBA is forecasting further improvement in the labor market and hoping

it would lead to a faster growth in wages, which would support not just

household consumption but also accelerate inflation.

     That forecast is based on business conditions that would be well-above

average, leading to an expectation that stronger demand will induce further

employment and eventually lead to stronger non-mining investment growth and thus

acceleration in the economy's potential growth.

     Other factors supporting the optimistic employment outlook is the

government's spending on infrastructure, which Lowe described as "having an

material effect on the economy."

     "We hear through our liaison program that businesses, particularly in

construction-related occupations, have their order books filling up and they are

much more optimistic about the future because transport construction is actually

helping," Lowe said in his parliamentary testimony.

     The RBA's current forecast is for the unemployment rate to fall to just

under 5.5% by the end of 2019. That is only a small drop from the current 5.6%

jobless rate, but as the rate moves closer to the 5.0% mark that the RBA

considers as full employment, the central bank is hoping it would slowly reduce

the under-employment rate, too. 

     "So our strategy is to have the unemployment rate gradually come down, with

relatively strong growth in employment over time, and that will help some of

these concerns dissipate," Lowe said, referring to slowing wage growth and

underemployment.

     But what happens if the RBA's forecast for the labor market doesn't come to

pass?

     The risk is not negligible. The various components that make up an improved

labor market need to ultimately result in household income growth that supports

spending. If risks materialize, the RBA may have to bring easing back to the

table because not doing so could mean exacerbating the very risk it is trying to

avoid: a slowing labor market leading to a prolonged period of higher debt

relative to income.

     One of the key concerns would be any further appreciation in the exchange

rate, which the RBA has already said could lead to a "slower progress in

reducing employment."

     A key question for the labor market outlook is how employment-intensive

future GDP growth will be given LNG production is not expected to add many jobs.

LNG exports are expected to be among the main contributors to GDP growth in the

period ahead, adding a bit under half a percentage point in each of the next few

years.

     The other key risk would be the sustainability of the elevated business

conditions seen in recent months amid lower consumer confidence and political

uncertainty. Any easing in business conditions raises the risk of a stalling in

employment growth prospects.

     Even as business conditions as measured by the National Australia Bank's

business survey are at their highest level since early 2008, consumer sentiment

as measured by Westpac-Melbourne Institute's is below the 100 mark for the ninth

month in a row -- the longest period of weak readings since 2008.

     It is unclear how this disconnect will be resolved in the coming months and

there is a growing risk that the household sector could weigh on the business

sector if low level of sentiment is any indicator of their reluctance to spend.

     "We remain apprehensive about how the disconnect between the business and

consumer sectors will be resolved -- especially in light of sluggish retail

conditions in July," NAB's chief economist Alan Oster said in his commentary on

the July survey. 

     "Additionally, the previously emphasized hurdles to growth -- elevated

underemployment, household debt and peaks in LNG exports and housing

construction -- remain firmly in place. These factors will weigh on the

longer-term economic outlook, following a reacceleration of growth in coming

quarters from the temporary disruptions to activity seen earlier in the year,"

Oster said.  

     Adding to the household spending risk is the recent increase in electricity

prices. At the same time as the household sector is dealing with slow growth in

wages and higher levels of debt relative to income, it also has the added

headwind of costs impinging on their budgets. 

     That means income growth needs to pick up fast enough to offset the impact

of these costs.  

     "If income growth doesn't pick up then I think it's unlikely that the

saving rate will keep coming down, because people will adjust their consumption

spending. This is why I've spoken quite a lot about the benefits of slightly

faster income growth, because if income keeps growing at the rate it's grown at

for the last four or five years then consumption will eventually have to respond

to that," Lowe said.

     Australian labor market data for August are due to be released on September

14. 

--MNI Sydney Bureau; tel: +61 2-9716-5467; email: sophia.rodrigues@marketnews.com

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