RBA risks 'major policy error': 'View is obsolete'

Unfortunately, it had to happen. In June, unemployment rose in reaction to the economy slowing to its weakest non-pandemic pace since the early 1990s.

Annual GDP growth is just 1.1 per cent and shows no sign of picking up. The unemployment rate, which was at a near 50-year low of 3.5 per cent in the middle of 2023, has risen to 4.1 per cent.

The sharp and unrelenting fall in job vacancies and job advertisements, plus the ongoing broader economic weakness, points to yet higher unemployment in the months ahead.

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“How high” is the question that the Reserve Bank of Australia (RBA) is mulling over as it prepares for its next Board meeting in early August.

At its last forecast round in May, it was predicting the unemployment rate to peak at 4.3 per cent, a level that now looks fanciful given the loss of economic momentum in recent weeks.

In human terms, the number of people unemployed has risen by 117,000 people from the low in October 2022.

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Similarities with the US labour market 'noteworthy'

Over the last year, the US unemployment rate has risen from 3.5 per cent to 4.1 per cent – the same as in Australia.

And unlike Australia, US annual GDP growth has been resilient, hovering around 2.5 to 3 per cent. In Australia, GDP growth has slowed from 2.5 per cent to a non-pandemic, 32-year low of a miserable 1.1 per cent.

On this score alone, the rise in the unemployment rate in the period ahead is likely to be more extreme in Australia, as the usual lags kick in.

The big difference between the US and Australia is in interest rate expectations.

In the US, the first interest rate cut in the cycle is fully priced in for September and by the end of 2025, approximately 150 basis points of rate cuts are expected by investors.

In Australia, despite the double of weak growth and rising unemployment, the market, quite bewilderingly, is pricing in the possibility of interest rate hikes within the next few months before a moderate easing of barely 50 basis points by the end of 2025.

Something is not quite right with this pricing

Many market participants have highlighted the local June quarter inflation data, due for release on July 31 – a week before the RBA meeting – as a factor that could still trigger a rate hike.

This view is obsolete.

Given the slump in the economy and the rise in unemployment and the certainty that regardless of that result, the RBA will be revising its inflation forecasts for 2025 and 2026 lower on the back of the deteriorating outlook and the impact of electricity and rent assistance from various levels of government means an “on hold” decision is highly likely.

Even if the inflation rate is at or even a tick above expectations, the weak economy, rising unemployment and elevated economic stress remain.

These factors will dominate the inflation result, at least in the eyes of the RBA who, it must be remembered and emphasised, has a mandate to maintain full employment as well as 2 to 3 per cent inflation.

It could be argued that the economy is at risk, severe risk even, of this mandate being broken with the unemployment rate on its way higher.

This is why a rate hike would be a major policy error.

Indeed, the RBA could frame a thoroughly realistic economic outlook where growth remains weak, at around 1 to 1.5 per cent, where the unemployment rate tracks towards 5 per cent with wages growth easing to 3 to 3.25 per cent and inflation locked into the 2 to 3 per cent target from next quarter – September 2024.

Indeed, that’s my forecast and on the basis of that, there seems little doubt the next move in interest rates will be down.

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