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As the economy slows, so does the labour market

The jobless rate may have snapped back in February but it will almost certainly fave a 4 in front of it by year's end.

Composite image of a male retail worker and a female electrician on the job after a fall in unemployment..
The unemployment rate dropped in February after rising slightly in December and January. (Source: Getty)

The labour market remains in decent shape, with a welcome snap-back in employment in February after two straight months of falls.

That rebound in monthly employment was anticipated by economists, but it does not hide the fact that the rate of jobs growth is slowing on the back of the softening in the economy more broadly. The next few months of labour force data will almost certainly show a further easing in employment growth.

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The February labour force data showed the unemployment rate easing back a touch, to 3.5 per cent. It has been around this rate for the past eight months, and it is clear there will be no further reductions in unemployment as the economy slows.

The bigger question is by how much the unemployment rate will rise, as demand for labour eases and as immigration inflows remain strong.

It is not just the official labour force data that is showing relative stability in labour market conditions or, indeed, pointing to a further slowing in job creation in the months ahead.

The various measures of demand for labour from job vacancies and job advertisements have all topped out and are heading lower. Indeed, at current levels and, assuming no more falls, the level of job ads is consistent with the unemployment rate rising to 4.5 per cent later in 2023 or early 2024.

An unemployment rate around 4-4.5 per cent is the rate that the Reserve Bank (RBA), Treasury and most economists estimate to be the rate of full employment. In other words, the unemployment rate that is consistent with solid economic growth, moderate rises in real wages and no upside pressure on inflation.

The critical issue for the unemployment rate is economic growth.

When economic growth is strong, demand for workers increases and the unemployment rate tends to weaken. When the economy slows, demand for workers decreases and unemployment tends to increase.

If, as is increasingly likely, GDP growth falls to 1.5 per cent through both 2023 and 2024 - which, coincidently, is the RBA’s forecast - the unemployment rate will rise.

Any undershoot on that GDP forecast and the unemployment rate will rise to an uncomfortable level near 5 per cent. This will be bad news and reflect an overshoot on the informal target for unemployment.

But, even at 4.5 per cent, the amount of slack in the labour market is likely to be sufficient to dampen wages growth, which is already struggling to get to 3.5 per cent. This was the case even when unemployment was at a near-50-year low.

All of this points to the RBA needing to pause its aggressive interest-rate-hiking cycle when it next meets on April 4.

The hard data on the Australian economy support the case for an ‘on hold’ decision, including the labour market data for February. Throw in the elevated uncertainty surrounding the US banking sector and growing risks of a US recession and the case for leaving official interest rates steady is closed.

With the US and European banking problems, the market was starting to price in an interest rate cut from the RBA in the not-too-distant future. This looks to be the market getting ahead of itself, and the solid labour force data suggest there is no need, yet, for the RBA to cut rates.

If the unemployment rate rises towards 4 per cent and then beyond, the calls for interest rate cuts will grow.

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