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Back on the 6th February, RBA Governor Philip Lowe gave a speech titled "The Year Ahead". At the time, this speech was notable because the Governor effectively shifted to a 'neutral' policy stance from its long-held mild tightening structure (as covered here). That understandably gained a lot of attention, though what was probably overlooked was the Governor's observation on what the Bank would be focused on in the months ahead;
"In the event of a sustained increase in the unemployment rate and a lack of further progress towards the inflation objective, lower interest rates might be appropriate at some point. We have the flexibility to do this if needed"
That statement highlighted the importance of developments in the labour market to policy considerations going foward. The Governor's assessment at that time was that labour market conditions were strong; "The national unemployment rate currently stands at 5 per cent, the lowest in over seven years", while the detail from the forward-looking indicators pointed to ongoing robust employment growth.
While the GDP growth outlook was ultimately downgraded in February's Statement on Monetary Policy for 2019 (from 3.25% to 3.0%) and 2020 (from 3.0% to 2.75%), the Governor was unperturbed in forecasting a decline in the unemployment rate to 4.75% by 2020. In that situation the Governor noted; "Our expectation has been – and continues to be – that the tighter labour market and reduced spare capacity will see underlying inflation rise further towards the midpoint of the target range".
Over the ensuing period, there were more speeches RBA officials; Christopher Kent (15/2), Philip Lowe (6/3), Luci Ellis (26/3) and Guy Debelle (19/4). Summarily, the comments on the labour market focused either on pointing out that conditions had been stronger than expected, or that the central scenario was for the unemployment rate to decline.
Given that GDP growth in Q1 was 2.3% through the year -- the Bank had expected it to come it at 2.75% -- it was not surprising to see that the minutes from April's Board meeting featured a quite detailed analysis of the labour market. Though to complicate matters, the Board had noted 'tension' between those indicators; "The labour market had continued to improve in early 2019, despite the slowing in growth recorded in the national accounts through 2018". The signals from the forward-looking indicators for employment growth were described by the Board as "mixed".
Given that uncertainty around the labour market, April's minutes revealed that the Board had the following discussion;
"Members also discussed the scenario where inflation did not move any higher and unemployment trended up, noting that a decrease in the cash rate would likely be appropriate in these circumstances"
That discussion is consistent with what the Governor outlined at his February speech. The earlier communication from the Bank indicated that developments in the labour market would take precedence.
Tuesday's decision statement, opted to focus on the positives regarding the labour market; "The Australian labour market remains strong. There has been a significant increase in employment, the vacancy rate remains high and there are reports of skills shortages in some areas". However, the Governor made the concession that "...there has been little further progress in reducing unemployment over the past six months". The Bank's clear focus on the labour market was summarised by the following line;
"...it recognised that there was still spare capacity in the economy and that a further improvement in the labour market was likely to be needed for inflation to be consistent with the target"
It appears from Tuesday's statement that the Bank still anticipates the unemployment rate to decline to 4.75%, though it looks like the timing will be pushed out to mid-2021 from 2020. The underlying inflation forecast appears to be lowered by 0.25% for 2019, reflecting Q1's much slower-than-expected outcome, before lifting back to 2.0% in 2020. That has certainly been a point of contention in markets, though it might be justified by the view that the unemployment rate is still expected to move lower over time, while transitory factors may have been weighing on Q1's inflation data. Note also that GDP growth appears to be forecast for trend (2.75%) in 2019 (downgrade of 0.25%) and 2020 (unchanged). None of this can be confirmed until tomorrow's quarterly Statement on Monetary Policy is released.
Going forward, the Bank needs to see the unemployment rate trending lower as per its forecast or it will cut the cash rate on the basis of bringing inflation back towards the target.