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Thursday, May 12, 2011

Unemployment holds at 4.85%, but June hike fading fast

As I have explained here before, a June hike was crucially dependent on two things: the labour market and wages data, with the Budget posing a curve-ball in the event that it was surprisingly austere (no problems there).

The jobs numbers today were weak. While March was revised up to 43.3k jobs created in the month (from 37.8k), and the UE rate held steady at 4.85% (slightly off from 4.92%), a total of 22k jobs were lost in the month, with 49k full-time jobs going and 26.9k part-time ones created. The saving grace for the UE rate, which technically declined, was the participation rate, which fell from its near all-time record high of 65.8% to 65.6%. As you can see from the chart below, the Aussie dollar/USD pair shaved more than a full cent.

The truth is that the monthly UE data are a crap-shoot with a wide 95% confidence interval for total jobs created of between -77k and +32.5k (the actual number was -22k). The more telling point is that the UE rate has been bobbing along around 5% since May 2010. So one school of thought would be that there is no real smoking gun yet for the RBA in terms of extreme labour tightness. The bullet is loaded, their finger is on the trigger, but it has yet to arguably fire. A structural break below 5% and wages growth will be the two catalysts for genuine concerns, according to this view of the world.

And there is no doubt that this new information puts the prospects for a June rate hike on the back-burner for the time being (pun intended). All eyes will now turn to the wages numbers. While in theory the RBA should not have trouble hiking in June given the recent inflation results and its outlook, the optics of June are getting harder. They will face a chorus of cries that the high exchange rate is cruelling the tradeable sectors of the economy. They will have a very ugly Q1 GDP number to contend with. And they will have the seemingly compelling argument that they should wait for Q2 CPI to be certain that core inflation is on the loose.

You know my view: I think they should have gone in May, just like I thought they should have gone in October last year. One major tactical advantage of going before Q2 CPI is that the RBA can argue that its tightening in November, and, say, June/July, has kept a lid on price pressures. More simply, the analogy they should be trotting out is this: if you are trying to keep a car within the 60km/hr speed limit, it is much easier to break and decelerate at 80km/hr than it is at 120km/hr. The same is true of price stability.

In summary, this is looking more and more like September-November all over again. Scores of people said they were mad to do a de facto double rate hike in November last year. After the Q1 CPI data, the November hike looked like a belated necessity, and the RBA had suddenly got 'behind the curve'.

The risk, again, is that the RBA waits until August, Q2 CPI prints on the high side, and then suddenly they are once more behind the eight ball. If, and it is an "if", Q2 does print high, Australia would have been running above-target core inflation for over half a year, with the outlook much worse. This in turn risks undermining the tenability of the RBA's overall inflation-targeting regime, which is not something I believe the Bank can afford.

Now before the doves get overexercised, which they almost certainly will, there is every possibility that the May labour data puts them back in their box. Leading indicators imply future jobs growth of 20-30k per month. However, economists thought the April numbers could print low as a function of two things: (1) an unusually long Easter break; and (2) statistical pay-back for a super strong March result, which has actually been revised up further from 37.8k to 43.3k new jobs. The UE data tends to be a bit autoregressive in this respect.

The key is the participation rate (and, of course, jobs growth). If the participation rate stays low, or continues to decline, we could easily see a 4.6-4.7% UE rate next month. So don't count your doves while the hawks are still in the sky...