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Jobs market in good shape but there are signs of cooling

The economy is slowing, thanks in no small part to the Reserve Bank's aggressive hiking of interest rates.

Composite image of two women working in office employment, and people crossing a busy city street.
The unemployment rate has hovered around the 3.5 per cent mark for the past six months. (Source: Getty)

The labour force ended 2022 in good health, although there are signs of a slowing in the rate of employment growth.

Total employment fell 14,600 in December, the first decline since July 2022. That said, the dip in jobs follows a trend for solid job creation over the second half of the year.

At the same time, the unemployment rate remained at 3.5 per cent - where it has hovered for the past six months - which remains a rate not seen since the late 1970s.

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It is important, nonetheless, to look at the labour market in context. The economy over late 2021 and the first half of 2022 was overheating. Economic growth was simply too strong, the economy had run out of workers and inflation was unleashed.

In simple terms, the economy had to slow, which is why the Reserve Bank (RBA) embarked on an interest-rate-hiking cycle. Part of the transition to slower growth, softer demand and, with that the journey to lower inflation, required a weaker jobs market. The eight interest rate hikes delivered during 2022 are now starting to work.

For the RBA, the labour market news will be welcome. That said, the unemployment rate and the current hard historical data on inflation will see it retaining a bias to hike interest rates at its next few board meetings.

This is a bias that is unlikely to be acted on with an actual rate hike, due to the signs of a broad economic slowdown and a series of other big-picture economic issues. Those issues include:

  • The lagged effect of the 300 basis points of tightening already in the system. There is a lot of policy contraction still to come

  • The yet-to-be-felt effect of the large number of mortgage holders still to have their fixed-rate mortgages reset at materially higher interest rates. This so-called ‘mortgage cliff’, while fully anticipated, will impact cash flows and spending for part of the household sector

  • The global economy is weakening. The risk of an economic hard landing is very real

  • Global inflation is in freefall and these disinflation pressures will be seen in Australia, which will help see inflation fall without the need for further local interest rate hikes

  • Commodity prices are trending lower, which will help dampen broad inflation pressures

  • Falling house prices are impacting household wealth and this will act as a major constraint on household spending through 2023. Further interest rate hikes are not needed and, indeed, if the wealth destruction continues much longer, the case to cut interest rates - not hike them - will be more apparent

While a year is a long time in economics and for monetary policy forecasts, there is a solid chance the RBA will go through the bulk of 2023 with interest rates on hold or with just one move as it fine-tunes settings as new data comes into play.

It is premature to talk of interest rate cuts, although if annual inflation starts to track towards 2.5 per cent with the unemployment rate lifting to 4.5 per cent, the case for a rate cut would be overwhelming. This is more a question for late 2023 than today.

In the US, the Federal Reserve looks like continuing its rate-hiking cycle - in a reckless fashion in the face of falling inflation and a looming recession. It will almost certainly have to reverse those policy mistakes before year’s end.

The money markets are pricing in a quite aggressive interest-rate-cutting cycle in the US from the second half of 2023, after further hikes from the Fed in the next couple of months. Such is the market view of the Fed’s policy errors and its confidence that inflation will be beaten.

Until then, it will be all eyes on the unfolding trends in economic growth, the labour market and inflation.

If we see weak growth, rising unemployment and a freefall in inflation, monetary policy will quickly turn from the narrative of aggressive interest rate hikes to speculation about rate cuts.

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