Cliff Notes: Labour Market Offers Hope for the Medium Term

Key insights from the week that was.

In Australia, the week began with another sombre update on confidence. The Westpac-MI Consumer Sentiment Index returned to deeply pessimistic levels, down 2.6% to 79.9. The RBA’s decision to raise the cash rate was a key factor, as evinced by the sharp fall in sentiment between those surveyed before the decision (83.0) and after (78.2). Cost-of-living pressures and renewed concerns over interest rates point to weak holiday season spending; 40% of households plan to spend less on gifts this Christmas than last. This result is consistent with the family finances and spending on ‘major household items’ sub-indexes being well below long-run average levels.

The labour market remains a bright-spot amid a gloomy outlook, however. The October labour force survey reported that employment increased by 55,000 (0.4%) in the month and hours worked gained 0.5%. Temporary hiring associated with the 2023 Australian Indigenous Voice referendum may have provided support, but the impact is uncertain.

What remains clear, however, is that Australia’s migration boom continues to expand the labour force, the participation rate returning to its post-WWI record high of 67.0% in October, seeing the unemployment rate rise to 3.7% even as employment grew above trend. In the months ahead, a further softening in hours worked is likely before employment experiences a material slowdown below trend.

In-step with the resilience of the labour market, wage outcomes also remain supportive. Q3’s 1.3% lift in the wage price index was in line with expectations, but the composition offered some surprises. A larger-than-expected contribution from awards and enterprise bargaining – a consequence of the minimum wage and aged care wage decisions as well as CPI indexation – was offset by a softer outcome from individual bargaining, a segment which tends to be more reactive to labour demand/ supply.

This detail suggests upside risks for aggregate wage growth are limited, increasing the probability of the RBA being able to achieve their aim of preserving the gains made on unemployment since the pandemic while bringing inflation under control – a topic discussed by Westpac Chief Economist Luci Ellis this week.

The latest NAB business survey also continued to report welcome progress regarding inflation. Following a sharp moderation in September, momentum in purchase costs, labour costs and final product prices all continued to ease in October, albeit at a slower pace. These results are within the context of a step-down in business conditions from last year (+13 vs. +25) and weakness in business confidence, the current level below the long-run average (–2 vs. +5).

Moving offshore, US consumer prices were flat in October against expectations for a 0.1% gain, leaving annual inflation at 3.2%yr from 3.7%yr in September. Falling oil prices were the primary cause of the deceleration in the month, although core prices also came in below expectations at 0.2%. Within the core basket, goods prices have, at the margin, declined for five consecutive months. Disinflation also looks to be broadening through services ex-shelter, indicating softer consumer demand and business pricing power. As shelter retreats in coming months, the FOMC’s 2.0%yr will come within reach, likely mid-2024.

Retail sales meanwhile were broadly as expected in October, roughly flat for the month and up 2.7%yr. 2023’s pattern has been periods of strength followed by a lull. If we are right in expecting GDP growth to slow below trend, sales growth will remain weak through year-end without another acceleration. Savings, real income growth and uncertainty over the outlook are all headwinds.

Despite these developments, commentary from FOMC members remains cautious. Chicago Fed President Goolsbee highlighted the importance of rents to the next leg down in inflation, while San Francisco Fed President Mary Daly warned against prematurely claiming victory over inflation. To manage risks, it is prudent for the FOMC to support term interest rates around current levels into the new year when, on the current trend, the CPI will be much closer to target.

UK consumer prices were also flat in October. Benefitting from 2022’s high base – established by strong energy and fuel prices before subsidies took effect – annual inflation also jolted lower in October from 6.7% to 4.6%. Outside energy, substantial progress has been made with goods disinflation; however, services inflation remains sticky, contributing 3.0ppts to the CPI, i.e. two thirds of headline inflation, only 0.2ppts less than September. The Bank of England has said they expect services inflation to remain robust for some time. A meaningful turn must materialise before rates can be cut. Enduring strength in wage growth adds to the uncertainty regarding services inflation. Over the year to September, total wages rose 7.9%yr.

Coming back to Asia, China’s October activity data was again mixed. Base effects were favourable for retail sales, the pulse of recent months solid but not strong, 6.9%ytd. Fixed asset investment growth meanwhile continues to be held down by weakness in the property sector, respectively 2.9% and –9.3%ytd. The underlying detail of fixed asset investment ex property remains very positive though, with growth in infrastructure and manufacturing investment holding up. Rumours of significant support for the property sector offer the promise of more balanced investment and improving sentiment amongst households and businesses in 2024 if delivered on by authorities. Our expectation of 5.3% growth in 2023 and 2024 depends on further effective stimulus in the months ahead.

Finally, Japanese GDP fell 0.5%qtr in Q3 driven by weakness in domestic demand. Household consumption declined 0.1%qtr following a 0.9%qtr decline in Q2. Exports increased another 0.5%qtr after a substantial 3.9%qtr increase in Q2, but strength in imports offset much of this gain. These results argue for accommodative fiscal and monetary policy to help mitigate the loss of lost purchasing power experienced by households due to inflation.