MNI: RBA Labour Market Rethink Seen Making Cuts More Distant

MNI (MELBOURNE) - The Reserve Bank of Australia’s hawkish reassessment of the labour market, which it now sees as tighter than it had previously considered, means investors are over-estimating the probability of swift rate cuts, former officials and economists told MNI.

The RBA is only likely to cut the cash rate from 4.35% in Q1 2025 after it reviews 2024 Q3 and Q4 data, said Justin Fabo, founder and head of research at Antipodean Macro and former head of international financial markets at the RBA, despite market pricing for 4.08% by December.

“That assumes the labour market continues to ease in terms of capacity,” he said. “That is the key risk to earlier cuts. The RBA will be watching the next unemployment prints closely.”

The RBA stated in its August Statement on Monetary Policy following its decision to hold rates at its last meeting that there is more excess demand in the economy and labour market than previously thought, “both now and throughout the forecast period,” noting inflation had proved higher than its previous estimates could explain. (See MNI RBA WATCH: Board Holds, Shrugs Off Market Volatility) 

Fabo said the RBA is internally debating its view of the level of full employment, while the 4.4% unemployment rate it foresees by mid-2025, which would be close to its last estimate of the non-accelerating inflation rate of unemployment (NAIRU), was wishful thinking. The jobless rate will likely sail past that level for some time if inflation is to get back to the Bank's 2.5% midpoint target, he warned.

LABOUR MARKET PUZZLE

The Australian labour market's unique nature has led some officials to question the RBA’s existing unemployment models, Fabo noted, pointing to the rising participation rate alongside growing unemployment. “In six months the relationship might reassert itself, but it hasn’t yet,” he said.

Workers were staying in jobs while employers refrained from layoffs, he added, indicating most people believed the economy was sluggish. Those outside the labour force who found it difficult to find work had driven the higher unemployment rate, he said. 

Fabo pushed back against recent claims made by some economists that revisions to hours worked may have driven the Reserve’s adjustment, noting its models had likely suggested excess demand was higher than previously thought for some time. 

“It's purely the evolution of the data and their models, and then maybe having more confidence to say it out loud that this is a possibility,” he told MNI, noting the narrative shift was needed should the board hike again or hold for longer than anticipated.

Mariano Kulish, University of Sydney professor and a former RBA senior manager, said the Reserve should have adjusted its view on excess demand and the labour market a while ago. 

The RBA included a chapter in the May SoMP on measuring the potential output gap and has been evaluating its labour market view since April. (See MNI: RBA To Look At Underutilisation In NAIRU Revamp) 

The RBA's shift and Governor Michele Bullock's recent statements suggested rates would likely stay on hold for some time, but that a hike is possible, Kulish said. "The [RBA] is not sure whether inflation will come back on its own or if they have done enough, and maybe it's changing its tune to prepare for an interest rate rise," he added.  

FISCAL OVER-STIMULUS

Fiscal policy is pushing the economy in the wrong direction and adding to aggregate demand, which will lead the Reserve board to hold the cash rate for the next six months at least, said Andrew Barker, senior economist at the Committee for Economic Development of Australia, and a former economist at the Organisation for Economic Co-operation and Development and at the Productivity Commission. 

“The concern is when we get into 2025, is the Reserve going to move early enough once inflation does move lower?” he cautioned, adding weak wage growth suggested the labour market is looser than the RBA’s view.

“We expect productivity to be coming back this year and helping that square the about 4% wage growth with getting [inflation] back to the 2-3% target band. We don't see the labour market being tight enough to be inconsistent with getting back to the [2-3%] target band.”