Through 2022 the Australian economy rebounded much more strongly and with greater inflationary pressure than anyone expected at...
Through 2022 the Australian economy rebounded much more strongly and with greater inflationary pressure than anyone expected at the beginning of the year. The RBA was forced to deliver an unprecedented eight consecutive monthly interest rate hikes and as the year draws to a close still very tight labour market conditions indicate that the battle to return inflation to a low and sustainable annual rate still has a way to run. At the very least, the RBA will need to start 2023 at its first policy meeting in February with another rate hike.
The threat of persistently high inflation is still alive and well as 2022 comes to a close. While the initial supply-side pressures that drove up inflation have started to diminish, demand is running strongly enough to ensure that annual inflation while diminishing will base at this stage in 2024 or 2025 above 3% y-o-y, unacceptably high. The power driving demand is over-full-employment that means that while the wage price index may be running at an acceptably low 3.1% y-o-y in, total wage compensation in the economy adding in employment growth, people getting more hours and more people working multiple jobs is running above 10% y-o-y.
Everyone expects that the strength in the labour market extending to demand will diminish in the first half of 2023 and that by the second half 2023 the unemployment rate will climb a little, the marker for the RBA that its rate hiking work is done for this cycle. The problem is that there is no sign in the latest labour market reading for November 2022 of any weakness. Indeed, rather the opposite is true and the numbers were stronger than in October.
Employment growth in November was much stronger than expected, up 64,000 (market consensus forecast +17,000) after an upwardly revised 43,100 increase in October (initial reading 32,200). Annual growth in employment in the year ending November was 4.2% or 553,700, the biggest cause of why annual growth in total wages paid is running so much higher than the annual rise in the wage price index.
The strong labour market is dragging more people in to participate with the participation rate lifting to a record high 66.8% in November from 66.5% in October. The big lift in participation rate meant that the large rise in employment did not generate a lower unemployment rate, although at 3.4% in November it remains lodged at its lowest level since 1974 and is showing no signs of increasing. The RBA will need to see some lift in the unemployment rate over two or three months to consider its rate hiking work complete.
There are reasons to expect the unemployment rate to base and start to rise in 2023. Global economic growth is slowing presenting a headwind to Australian export sales. Although idiosyncratic factors such the Ukraine war and global food supply issues could continue to provide some offset to downward pressure on export demand from slowing global growth.
Australian domestic demand will come under increasing pressure from higher borrowing interest rates. The full lagged impact of recent interest rate hikes is still coming. Variable interest rate borrowers are only just starting to see in their payment schedules the October and November rate hikes over the Christmas and early New-Year period. Two- and three-year fixed rate commitments contracted at very low interest rates in 2020 and 2021 are rolling over at much higher interest rates and in large numbers in the first half of 2023. Demand growth may weaken and possibly quite sharply. However, while people are very fully employed that may serve to support stronger demand for longer.
It all comes back to what happens to the labour market in the first half of 2023? If demand in the economy softens more broadly beyond housing, the most interest rate sensitive sector, that may take some of the strong edge off the labour market.
It is also possible that increasing immigration could help to lift labour supply limiting upward pressure on wages. It is worth noting, however, that net immigration levels may not be as strong as expected. Australia is not alone trying to attract migrants to help ease tight labour market conditions.
The ABS released last week migration figures for the 2021-2022 financial year. Net migration jumped to +171,000 from -84,900 in 2020-2021. In 2021-2022 total migrants to Australia were 395,000 against 224,000 Australians who migrated overseas. Driving net migration up to the average 250,000 per year mark that prevailed in the three years before the pandemic will be a tough ask, but those are the figures that are needed to make a material dent in current labour market shortages.
Our forecasts at the end of 2022 for 2023 have the forces dragging down demand growth outweighing those that provide support. We expect the unemployment to start to rise in the first half of 2023 and that may give the RBA the chance to get away with just one more rate hike in February taking the cash rate to a 3.35% peak where it stays until there is clear evidence that the unemployment rate is lodged higher. Getting that evidence may take all of 2023 and perhaps a few months of 2024. Beyond February, we do not see the cash rate being any lower than 3.35% until mid-2024.
We admit that if the strength shown in the November labour force report repeats in the December and January reports the RBA will have more rate-hiking work to do than we are forecasting. The peak for the cash rate in this circumstance will be higher than 3.35% and because of the additional damage that would wreak given high household debt the first rate cut would come sooner, possibly late in 2023.
This is the last economic report for 2022, the next edition will be on Monday 9th January 2023. Wishing readers a happy and safe holiday season.