Monday, August 10, 2015

Labour markets and monetary policy

The past week has seen important labour market releases out of New Zealand, Australia and the United States – at a critical juncture for monetary policy considerations in each of these countries.

In New Zealand June data showed employment growth slightly below expectations over the quarter but still coming in at a healthy +3.0% annual clip (+68,000 jobs).  That's down from 3.2% in March and expect a further slowdown in growth as growth in the economy more generally slows over the period ahead.

The unemployment rate ticked higher again to 5.9%, up from 5.8% in March, with strong migration continuing to fuel strong growth in the working age population.  That has combined with high rates of labour force paricipation to generate strong growth in the labour force.

It’s this significant increase in labour supply that has kept wages and domestic inflationary pressures subdued recently despite strong growth in both economic output and jobs.  Indeed the Labour Cost Index came in at +1.8% for the year – only just short of being consistent with 2% inflation – but going nowhere fast.

The monetary policy question in New Zealand right now is how much room there is for the RBNZ to cut interest rates.  While we expect employment growth to slow in the period ahead, the outlook for the unemployment rate is somewhat ambiguous as we expect growth in labour supply to slow also. 

At this point we’re still happy with our call of another two 25bp cuts to the Official Cash Rate in September and October, taking the OCR back down to the historical low of 2.5%.  We believe the significant fall in the (trade weighted) exchange rate will negate the need for more aggressive action on interest rates.

In Australia the question is whether the Reserve Bank of Australia is done with rate cuts or if there's more work to do.

In that respect recent labour market data there didn’t provide much guidance with mixed messages.  July data showed a stronger than expected increases in jobs over the month with annual growth now at a 4-year high of 2.1%.  But that came with a rise in the unemployment rate back to January’s level of 6.3%, up from 6.1% in June.  A rise in the participation rate was the catalyst for the rise in the unemployment rate - itself a sign of a healthy well-functioning labour market.

This result seems broadly in line with the comments from the RBA following their August meeting where the statement acknowledged somewhat stronger employment growth and a steady rate of unemployment over the past year.   This result therefore seems to suggest the RBA is on hold, at least for now. Our economics team in Sydney still think there is a “50/50” chance of a rate cut later this year.

In the United States the question is what “some further improvement in the labor market” the FOMC needs to see  to push the lift-off button looks like and whether July’s data fits the bill. 

July saw payrolls growth of 215k jobs, an increase in hours worked of +0.5%, a +0.2% increase in average hourly earnings (annual rate +2.1%) and a steady unemployment rate at 5.3% (although the broader U6 measures nudged lower to 10.4%). 

September rate hike chances took a bit of a hit following the recent lower-than-expected increase in the June Employment Cost Index (ECI), but we don’t think that will deter the Fed from hiking soon.  The June ECI data was probably compensation for stronger-than-expected wage growth in March data which the Committee was right to "look through".     

Wages are an important part of the inflation story and will inevitably be critical in determining the pace and extent of the interest rate cycle,  However its data on employment growth and more importantly measures of spare capacity such as the unemployment rate that will determine the extent of the Committee's confidence that inflation will return to 2% in time.

I think the July employment data was good enough to keep odds of September lift-off at still a touch over 50%.