Lags, jobs and interest rates

Thu, 13 Feb 2014  |  

I was wrong.

The RBA is not going to hike interest rates in March after all, simply because of the persistent degree of slack in the labour market.

In my judgment, the stellar lift in dwelling construction, exports and consumer demand, all event from around the middle of 2013, would have been sufficient to kick in to solid employment growth by now.

But employment fell 3,700 in January after falling 23,000 in December to lock in a slightly disconcerting trend for the jobs market. The unemployment rate, at 6.0%, is obviously too high and needs to edge back towards 5.75% before the RBA will consider hiking rates.

While aware of the oft-discussed lags (it always takes 6 to 12 months of stronger economic growth before there is an upswing in the labour market), the current economic upswing might be erring at the longer end of that lag. We'll see. This quite simply means that policy should be kept easier for a little longer before the inevitable normalisation of interest rates needs to occur as the unemployment rate heads lower.

In September last year, I came to the view that the RBA would need to hike interest rates in each quarter of 2014. This was a view I held till today. At the time I made this call, the market was pricing in approximately 30 to 35 basis points of cuts, so even with no hike and rates n hold over that time, I am crying all the way to the bank (as are a few clients).

According to the Bloomberg survey of early September 2013, there were 10 economists forecasting rate cuts in Q4 2013, a view that that has had to be revised with the flow of news, events and data. Some switched their cut view to Q1 2014, alas only to revise their views in recent times. Such are the joys of markets and forecasting.

So where to now?

Even in light of the disappointing jobs data, housing construction is still booming, house prices are still elevated, exports are still at record highs and consumer spending it adding a decent chunk to economic growth. Business is increasingly upbeat about the outlook and the global economy is still expanding.
All of which means that employment will lift, maybe next month or the month after, but certainly before the middle of 2014 as these dynamics in the expansion of the economy finally spill over to the labour market.

The interest rate hike from the RBA is now probably a few months away – let's say June, July or August at this stage (there's still money to be made with the market still pricing in a few ticks of rate cuts), and the profile of roughly 25 basis points of hikes per quarter after that remains appropriate.
The wages data next week will be vital for the rate outlook as will of course the March quarter CPI which is due for release in late April. It is obvious that these will carry a lot of weight when it comes to the RBA policy deliberations.

While ever the RBA keeps interest rates where they are and the Australian dollar holds at 90 cents, let alone falls below this level, a pace of GDP growth at 3% and more will be sustained.

This will translate into jobs, with the only questions when and in what order of magnitude.

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