Australia May employment data delivered a big beat on expectations, the headline unemployment rate fell to 5.1% even as participation increased, rounding out the 4th largest quarterly fall in unemployment on record. Australian employment is now 1% above its pre-pandemic peak.

Notably the underemployment rate fell to 7.4% which is the lowest level in 7 years. Underemployment (those employed but wanting to and available to work more hours), another contributor to labour market slack, typically accounts for most of the weakness in wage growth, rather than unemployment itself. Numerous recent research concludes that in recent decades underemployment has had a stronger relationship with wage growth than unemployment.

Against this backdrop the spotlight remains on the RBA’s ongoing challenge to meet mandated price targets, achieving their goal of a tighter labour market, wages growth and hence inflation. And alongside this their ability to wind back accommodative policy settings.

Governor Lowe has stressed the RBA’s more reactive policy stance/inflation-targeting regime now requires actual, not forecast, inflation to be within the 2-3% target band before raising rates. This likely requires wages growth in the order of 3%, and a headline unemployment rate tracking 4% and probably below. The last time unemployment was close to 4% was back in August 2008. At present, the economy is far from full employment or full capacity, significant labour market slack remains, promoting weakness in wages and demand and limiting any underlying inflationary pressures. Despite those end goals remaining a long way off the economy continues to track a stronger economic trajectory than forecast.

The continued recovery in the labour market raises the probability that the RBA are perhaps too pessimistic at this stage and that rates will lift off sooner than expected. However, the decline in labour market slack required to promote sustained wages growth in the order of 3% remains an unknown. Although in combination with a continued decline in underemployment and emergent skills shortages with closed international borders cutting off migrant workers, there is evidence that wages are turning a corner and could soon accelerate. Lowe citing today that there could be more upward pressure on wages if border remains closed for another year.

Were the RBA to extend, this would signal that the bank does not expect inflation to be sustainably back between their 2-3% target until late 2024, and correspondingly lift rates until late 2024 and beyond. 

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