Macro (Re)view (14/6) | Excess capacity key for the RBA

The Reserve Bank of Australia (RBA) remains on track to lower the cash rate further this year after this data this week confirmed that excess capacity in the labour market remains elevated. In line with other major economies, the RBA has come to accept that Australia's level of 'full employment' is now lower than its previous estimates. An in-depth insight into the Bank's thinking behind this important shift was provided this week in a speech by the RBA's Assistant Governor Luci Ellis (see here).

As outlined therein, while the non-accelerating inflation rate of unemployment (NAIRU) or 'full employment' concept is inherently unobservable, the signals from the data flow have led to the Bank concluding that Australia's labour market is essentially operating below capacity. The RBA's current estimate is that the unemployment rate can fall to around 4.5% before wage and inflationary pressures will begin to build hence why the Bank is now easing the cash rate.

With that in mind, the key focus of the week was May's Labour Force Survey. Employment increased by a net 42,300 in the month -- much stronger than the 16,000 rise forecast by markets -- while April's initially reported figure of 28,400 was revised up to 43,100 (for a full review of May's report see here). This drove overall employment growth to 2.88% over the year -- its fastest pace since March 2018. However, while employment growth is robust, participation is strongly on the rise hitting a new record high of 66.0% in May. As a result, the unemployment rate remained in check at 5.2% (shown as our chart of the week, below) and highlights the high hurdle to lowering excess capacity in the prevailing conditions. 

Chart of the week 

Last week's National Accounts highlighted that private sector demand was soft in Q1 (see here) and that appears to remain the case in the current quarter according to the NAB's latest Business Survey for May. While business confidence spiked to a +7 reading from 0 in response to the federal election outcome, the conditions index fell from +3 to +1 to a now well below-average level and down from the peak of around +20 a year ago. That reflects declines across each of the subcomponents of trading, profitability, and employment over the past year. Meanwhile, the leading indicators for forward orders and capacity utilisation pointed to a further loss of momentum. Labour demand was anticipated to remain around average at +18,000 jobs per month, which if sustained implies the national unemployment rate is unlikely to decline over the next 6 months.

A downbeat tone was also evident in Westpac's consumer sentiment index in June, which softened by 0.6% to 100.7. The survey was conducted last week (3-7 June) and showed that pessimism towards the economic outlook over the next 12 months set in following the RBA's rate cut announcement and by the slowing in GDP growth in the Q1 National Accounts, with both events receiving widespread coverage in local news services. In spite of the rate cut and the tax relief measures in April's Budget, there appears to be a continued reluctance in consumers' attitudes towards spending; possibly due to a softening in labour market sentiment. For the housing market, the rate cut was assessed as a positive with the 'time to buy a dwelling' index lifting by a modest 1.8%. Of more significance, house price expectations surged by 22.7% in June reflecting the removal of uncertainty around tax policy following the federal election outcome.

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Markets abroad this week continued to be driven by news headlines with the economic data flow light. The announcement by US President Trump last weekend that the proposed tariffs on Mexico would be halted were a tailwind for risk assets early in the week, though the optimism faded following threats from the US to impose sanctions relating to Germany and Russia's planned Nord Stream 2 gas pipeline project. Geopolitical tensions were also in focus on reports that US oil tankers had been attacked in the Gulf of Oman, while there were week-long protests in Hong Kong over extradition laws to mainland China.  

In a relatively quiet week for markets the highlight was the US inflation data for May, with the headline Consumer Price Index slowing from 2.0% to 1.8% in annual terms while the core measure eased from 2.1% to 2.0% over the year. This comes ahead of next week's Federal Reserve meeting where markets will be paying close attention to the Committee's view on inflation and whether the slowdown is still seen as 'transitory'. Markets are fully priced for a US rate cut by July and will be disappointed if the Committee does not at least give a clear signal that easier policy is being considered in the face of an uncertain growth outlook impacted by trade tensions.

Following on from last week's European Central Bank meeting, Governing Council members Coeure and Rehn reiterated the message that they are ready to act if necessitated by a deterioration in the economic outlook. In the UK, the ongoing impacts of Brexit continue to be felt with GDP growth contracting by 0.4% in April, which slowed annual output growth to 1.3% from 1.9% reflecting weakness in manufacturing and business investment. Notwithstanding, the labour market remains robust with the unemployment rate at 3.8% -- its equal lowest since 1975 -- while wages growth lifted by an annualised 3.1% pace for the 3-months to April.