Key economic reports relating to labour market conditions and inflation are due over the next two weeks and what they show will...
Key economic reports relating to labour market conditions and inflation are due over the next two weeks and what they show will determine whether any hope remains that the RBA can start to cut the cash rate in late 2024. Our view is that the odds have moved against a rate cut in 2024 and the two key economic reports will reinforce our view. We expect that the March labour force report on Thursday this week will show consolidation of the outsized 116,500 increase in employment reported for February and with the unemployment rate lodged below 4% in March. We also expect that the Q1 CPI report out on Wednesday next week will show the annual CPI inflation rate around 3.5% y-o-y, but with underlying inflation (trimmed mean and weighted median) close to 4% y-o-y.
If these reports come in around where we expect, the RBA may need to push out the current (February Monetary Policy Statement) forecast of returning inflation inside 2-3% target band in the second half of next year. The next interest rate setting meeting and release of the quarterly Monetary Policy Statement occur on Tuesday 7 May and will need to reflect the tighter than previously expected labour market as well as the longer period where inflation is likely to be above target. The RBA may need to reintroduce in commentaries the possibility that more rate hikes cannot be ruled out.
Labour market conditions appear to be running most out of kilter with the RBA’s February Monetary Policy Statement forecasts. Those forecasts had the unemployment rate up at an average of 4.2% in Q2 2024 with annual growth in employment down to 2.0% y-o-y in June. In the February labour force report, the unemployment rate was down to 3.7% and annual growth in employment was 3.2% y-o-y. To achieve the RBA’s February Monetary Policy Statement forecasts for June employment can grow only 27,000 for the four months March through June, an average of 6,750 a month. Placing that required employment growth in context, employment growth averaged 32,550 a month in the previous four months November 2023 through February 2024.
It would require material weakening in demand for labour to reduce an average 32,550 monthly lift in employment to 6,750. If anything, aggregate demand in the Australian economy has firmed in Q1 2024 placing greater demand for workers. Labour shortages remain acute in key big employing sectors of the economy including construction, health and age care and education. While monthly employment readings may be volatile, on average they are still likely to grow at a substantial pace. In this context, any growth in employment in the March labour force report this week will force upward revision to the RBA’s 2.0% y-o-y employment growth forecast for June 2024.
With employment growing faster than forecast previously the RBA will also need to adjust the 4.2% average unemployment rate forecast for June 2024. The unemployment rate averaged 3.9% in Q4 2023. In the first two months of 2024 it is still averaging 3.9%. The consensus forecast for the March unemployment rate out this week is also 3.9%. To get an average 4.2% unemployment rate in Q2 2024, the unemployment rate needs to jump sharply (it was 3.7% in February) and then hold that higher level through Q2. A jump in this order is very unlikely in the current environment of still strong demand for labour.
In May the RBA will need to adjust its employment growth and unemployment rate forecasts to reflect a tighter than previously forecast labour market in mid-2024. That means it will need to revise higher near-term forecasts of wage growth as well.
Straight after the RBA’s February Monetary Policy Statement its near-term wage growth forecasts were looking too low. The RBA had annual growth in the Q4 2023 wage price index released just after its February forecasts at 4.1% y-o-y. It came in at 4.2% y-o-y and with developments since including still tight labour market conditions, several big wage settlements and the Federal Government still encouraging wage increases without requiring compensating productivity gains annual wage growth has likely lifted more in Q1 2024 and will be above the RBA’s February forecast of 4.1% y-o-y in Q2 2024.
After the pressure on the RBA’s labour market forecasts that is likely to show later this week, focus turns to the Q1 CPI report next week. In Q4 2023 the CPI was up 0.6% q-o-q, 4.1% y-o-y, while the two main underlying measures the trimmed mean and weighted median were up respectively 0.8% q-o-q, 4.2% y-o-y and 0.9% q-o-q, 4.4% y-o-y.
The high underlying inflation measures relative to the headline CPI mean that volatile and special elements of the CPI were helping to moderate the quarterly CPI lift. Those factors were food and beverage prices up 0.5% q-o-q, education costs -0.1% q-o-q, transport costs -0.2% q-o-q, and household equipment and service prices, -1.0%. The main factor working in the opposite direction was housing, +1.0% q-o-q.
The special factors look less dampening for the CPI in Q1 2024. Housing will rise at least 1.0% q-o-q. Food and beverage prices probably rose more than 0.5% q-o-q. Education price rises are always captured in Q1 each year at the start of the new year. A rise near to 1.0% q-o-q is likely. Household equipment and services may show price falls again, but not as large as in Q4 while transport costs could fall again with lower holiday travel costs offsetting higher petrol prices.
All told the CPI probably rose 0.8% q-o-q in Q1 taking annual inflation down to 3.5% y-o-y. Underlying inflation readings will likely be 0.8% or 0.9% q-o-q. These expected Q1 inflation readings are right at the upper limit if the RBA is going to achieve its February Monetary Policy Statement Q2 2024 CPI inflation forecast of 3.3% y-o-y, a pre-condition for getting inflation inside 2-3% target band in the second half of 2025.
Over the next two weeks, from the perspective of the RBA’s February economic forecasts, there is a high risk that the labour market report will be too tight, or the CPI will be too high. If one or both occur it will end hope of any RBA rate cut in 2024 and may open the possibility that the cash rate is not high enough.