Economics

Wage growth in the September quarter fell back slightly to a 2.2 per cent annual rate. The RBA’s updated forecasts from last Friday assume no significant progress on either unemployment or wage growth for the next two years, making it difficult for the central bank to reach its inflation target over the same period. On a slightly more positive note, there were modest improvements in business confidence in October and consumer confidence in November, although both indicators suggest overall conditions remain relatively subdued. This week’s readings include commentary from the Treasurer, the possibility of Australia’s own version of Brexit, the age of financial capital abundance, the economic and social consequence of Europe’s megacities, Latin America’s post commodity boom syndrome and reflections on Eastern Europe two decades on from the fall of the Berlin Wall.

What I’ve been following in Australia . . .

What happened:

The ABS reported that Australia’s unemployment rate edged up to 5.3 per cent (seasonally adjusted) in October, a 0.1 percentage point increase over September. Monthly trend unemployment remained unchanged at 5.3 per cent.

NAB 

The underemployment rate also increased last month, climbing by 0.2 percentage points to 8.5 per cent, taking the underutilisation rate back up to 13.8 per cent.

Underemployment 

Total employment decreased by 19,000 people over the month, with full-time employment down by 10,300 and part-time employment falling by 8,700.

Employment

The impact of that fall in employment on the unemployment rate was partially offset by a decline in the participation rate, which slipped slightly to 66 per cent in October. The employment to population ratio also dipped, falling to 62.5 per cent. But both series remain at relatively elevated levels, with the participation rate still close to its record high.

Population ratio

By state, the largest monthly increases in employment in October were recorded in Western Australia (up 6,300 people) and Victoria (up 2,900). The largest decreases were in Queensland (down 14,000), New South Wales (down 10,300) and South Australia (down 6,500 people). The unemployment rate increased by 0.3 percentage points in New South Wales to 4.8 per cent, and by 0.1 percentage in Victoria, again to 4.8 per cent. Unemployment fell in Tasmania (down 0.2 percentage points) and Queensland (down 0.1 percentage points), with no change in Western Australia and South Australia.

Unemployment rate by state

Why it matters:

Market expectations had been for an employment gain of 15,000 jobs and the unemployment rate to stay stable at 5.2 per cent, making October’s outcome quite a bit worse than anticipated on several fronts. The number of people in employment dropped, the participation rate fell, and both the unemployment and underemployment rates rose, taking the economy further away from the RBA’s estimate of a 4.5 per cent Non-Accelerating Inflation Rate of Unemployment (NAIRU). Moreover, not only was October’s fall in employment the first monthly decline recorded since May 2018, it was the biggest one since August 2016.

Taken in conjunction with the soft, albeit fully expected, Q3 wage outcome (see next story), this result paints a picture of an Australian labour market that in many ways is still stuck in the doldrums, with little progress towards the lower unemployment and faster wage growth needed to get the economy closer to the RBA’s inflation target. That’s fully consistent with the latest set of central bank projections (see below), but it also suggests that recent market optimism about the diminishing likelihood of a rate cut next February might have been a bit overdone. Certainly, that seems to be the implication of the immediate market reaction: at the time of writing, the implied probability of a rate cut at the December RBA meeting had increased to a bit more than 25 per cent from around 14 per cent before the unemployment print, while the odds for a February 2020 rate cut had increased to about 58 per cent from around 44 per cent.

What happened:

According to the ABS, the seasonally adjusted wage price index (WPI) rose by 0.5 per cent over the September quarter, and was up 2.2 per cent over the year. Private sector wages rose by 2.2 per cent in annual terms and public sector wages by 2.5 per cent, while overall wages including bonuses rose by 2.8 per cent.

Wage price index

By industry, wage growth in the health care and social assistance sector was the main contributor to the overall quarterly WPI increase, while other sectors with strong rates of annual increase included the utilities, transport, and professional, scientific and technical services.

Wage price index

By state, in annual terms public sector wages increase were largest in Victoria, reflecting the June quarter’s pay awards, while private wage growth was strongest in the ACT and Tasmania.

Wage price index

Why it matters:

Although the June WPI print was bang in line with the market consensus forecast, it also marked a slight fall in the annual pace of wage growth. As such, although expected, the outcome was still disappointing in the context of the stronger wage growth that would be required to help the RBA hit its inflation target and to spark some life into household consumption growth. But the quarterly data continue to show no sign of any such development, apart from a pickup in bonus payments. Indeed, in the latest Statement on Monetary Policy, the RBA now appears to have given up on its previous forecasts of a wage increase and become resigned to the prospects of wage growth stuck around its current levels for at least the next two years (see below).

What happened:

The NAB monthly business survey saw small improvements in both business conditions (up one point to plus three index points) and business confidence (up two points to plus three index points) in October. Both indicators remain below their long-run average of plus six index points.

NAB

By sector, conditions in trend terms were strongest in the services and mining sectors and weakest in retail and wholesale trade, while by state conditions were strongest in New South Wales, Western Australia and South Australia and weakest in Queensland and Victoria.

Forward-looking indicators have also picked up over the past couple of months, with forward orders now above average (albeit still negative on a trend basis).

Why it matters:

On the upside, the modest rise in both indicators indicates that October did bring some improvement for Australia’s business sector, which – along with the uptick in consumer sentiment recorded in November – can be taken as a piece of evidence in favour of the RBA’s ‘gentle turning point’ hypothesis. Given that both business conditions and business confidence readings remain below their long-run averages, however, any optimism on this front still needs to be qualified by the fact that the overall picture remains subdued.

What happened:

The Westpac-Melbourne Institute Index of Consumer Sentiment rose (pdf) 4.5 per cent to 97 in November, partially unwinding the sharp 5.5 per cent fall that had taken place in October.

Consumer sentiment index

All index components recorded an increase in November, with improvements in expectations of economic conditions, the state of family finances and time to buy a major household item. Less welcome, there was also an increase in the Westpac-Melbourne Institute Unemployment Expectations index this month, which hit its highest level since June 2017 (an increase in this index indicates that more consumers expect unemployment to increase in the year ahead).

Why it matters:

Although November did bring a recovery in consumer sentiment from October’s sharp decline, note that this still wasn’t enough to return the index to positive territory, with pessimists continuing to outnumber optimists.

In their commentary accompanying the release, Westpac economists continue to interpret these results as indicating that consumers have been more unnerved than reassured by the RBA’s cuts to the cash rate, pointing out both that not only has the index now fallen by around four per cent since the RBA starting easing policy in June1, but that the pattern of consumer confidence falling after a rate cut and recovering when the RBA leaves rates unchanged has now applied in both July-August and October-November. The RBA is aware of the possibility that lower rates could send a negative signal about economic conditions and raises it in the latest Statement on Monetary Policy (see below), but the central bank’s view continues to be that the benefits from lower rates continue to outweigh any potential adverse consequences.

What happened:

The RBA published the November Statement on Monetary Policy last Friday. The central bank said that ‘the outlook is largely unchanged from three months’ ago’ and stuck with its forecast that the ‘Australian economy is gradually coming out of a soft patch.’

The RBA has become slightly more downbeat on external conditions relative to its projections in the August Statement, with cuts to its forecasts of major trading partner growth. That’s because ‘there are more signs that the slowing in export-oriented sectors associated with US-China trade and technology disputes is spilling over to the service sectors.’ Risks to the international outlook include a renewed escalation in those disputes (although the RBA notes that recent progress on negotiations suggests that this outcome is now less likely); the danger that negative spillovers from trade to services and employment turn out to be larger than expected; the possibility of a disruptive Brexit; uncertainty over how Beijing will manage the policy trade-offs facing the Chinese economy; and the threat of a tightening in global financial conditions through higher risk premiums and financial market volatility.

In terms of the prospects for Australia, the RBA has trimmed its expectations for near-term GDP growth by about a quarter of a percentage point, with growth now expected to run at 2.25 per cent in the December quarter and average 2.25 per cent across 2019/20. That’s only a slight downgrade from the growth profile presented in the August Statement but is a markedly weaker outcome than the RBA was expecting this time last year: the November 2018 Statement projected that GDP growth would be 3.3 per cent in the December quarter and 3.25 per cent across 2019/20. Nevertheless, the RBA still thinks the economy has reached that ‘gentle turning point’ it has been referring to, with growth predicted to accelerate to 2.75 per cent in 2020/21 before hitting three per cent in 2021/22. That recovery in activity is expected to be driven by the combined effects of low interest rates, the recent tax cuts, continued infrastructure spending, the recovery in housing prices and a stronger outlook for the resources sector.

RBA Forecasts

Near-term risks to the outlook cited by the central bank include housing construction, where the RBA has already downgraded its near-term forecasts for dwelling investment but where it worries that the falls could be even larger than expected and drag down other parts of the economy, and the labour market. But from 2021 onwards it thinks risks become more balanced, with the possibility of a bigger than forecast recovery in construction and a faster than anticipated recovery in household consumption.

In terms of wages and inflation, the RBA sees little upward pressure ahead. Wage growth is now forecast to be little changed at around 2.3 per cent across the whole of the forecast period while unemployment is only expected to dip to just below five per cent by the end of 2021. Both headline and underlying inflation are forecast to rise to around 1.75 per cent through 2020 and to approach two per cent by the end of 2021.

Given this outlook, the RBA remains ‘prepared to ease monetary policy further if needed to support sustainable growth in the economy, full employment and the achievement of the medium-term inflation target over time.

Why it matters:

Unsurprisingly, the RBA’s latest set of forecasts are consistent with the story the central bank has been telling about the economy over the past couple of months. So, the RBA still detects a ‘gentle turning point’ in economic conditions and reckons that the combination of lower interest rates and tax cuts will help deliver a gradual return to stronger growth over the next couple of years.

Inflation

At the same time, however, with the unemployment rate expected to stay above the RBA’s estimate of a 4.5 per cent non-accelerating inflation rate of unemployment (NAIRU) throughout the forecast period, the central bank foresees no acceleration in wage growth. That contributes to an inflation forecast which has the rate of price increases only nudging the bottom of the RBA’s target band by mid-2021 and still there by year end.2 So the RBA’s best guess is that it will continue struggle to hit its inflation target, even in the context of a forecast which assumes that there is ‘some probability’ that the cash rate will fall to 0.5 per cent by the middle of next year.

All else equal, that should indicate that additional monetary policy effort will be forthcoming. As noted in previous issues of the Weekly, there had been a bit of a divergence of opinion emerging here. Financial markets had become significantly more cautious in recent weeks about the proposition that the RBA would deliver another rate cut, even as many bank economists remained convinced that the RBA would lower the cash rate by 25bp next February. As noted above, this week’s labour market and wage releases have jolted that financial market consensus somewhat and reinforced the case for a February rate cut.

For its part, the RBA signalled in November’s Statement that it ‘was mindful that rates were already very low and that each further cut brings closer the point at which other policy options might come into play.’ It also conceded that there was some risk that ‘further easing could unintentionally convey an overly negative view of the economic outlook, or that the usual channels of policy transmission might be less effective at low interest rates.’ Despite those considerations however, the RBA still thinks that ‘lower rates would support the economy via a lower exchange rate, higher asset prices and a boost to aggregate household disposable income.’

Pulling all this together, and the implication is that the RBA has only one or at most two rate cuts left in its arsenal, and after that will have to consider turning to unconventional monetary policy measures. In that context, the governor’s forthcoming speech on 26 November on Unconventional Monetary Policy: Some Lessons from Overseas will receive plenty of attention.

What might stop the RBA going down that road? One possibility of course is that the economic outlook turns out to be better than it expects. Another is that there is greater support from fiscal policy forthcoming than now looks likely to be the case, and that this support is large enough to remove the burden of further stimulus from monetary policy. A third possibility – and one that is canvassed in some scenario analysis at the end of the November Statement – is that a weaker Australian dollar comes to the central bank’s rescue. Box E describes how a sustained five per cent depreciation in the trade-weighted index (TWI)3 relative to the current baseline would push GDP growth roughly half a percentage point higher than the current forecast, sending the unemployment rate down towards 4.5 per cent and rising trimmed mean inflation to 2.25 percent by the end of 2021. Which would suit the RBA quite nicely, thank you.

What I’ve been reading: articles and essays

The Treasurer gave a speech on Australia and the global economy, making the case for recapturing the Bretton Woods moment. The latter would involve a ‘reinvigorated’ WTO with ‘a more effective dispute settlement mechanism and a broader remit to deal with e-commerce and the opportunities created by the digital economy’ along with an IMF where there would be ‘change to the governance structures reflecting the greater role played by emerging economies, particularly in Asia.’ Closer to home, the Treasurer emphasises ‘Responsible and disciplined fiscal and economic management’ along with ‘Building an education system that both supports human capital here and exports those services to the region’ and that can ‘train people in the services and digital technologies of the future.’

The Treasury released a consultation note on the economic infrastructure staples tax concession. I must confess that the taxation details here are a bit outside my comfort zone, but for those keen to know more, here is some helpful background on stapled securities and here (pdf) are some details on Treasury’s 2018 introduction of new integrity measures relating to staples and their on impact infrastructure investors.

The ANU’s Gordon De Brouwer on managing risk in Asia when security and economics collide. His suggestions include ‘strong governance — including objective cost-benefit analysis, competitive, open and non-discriminatory bidding, and independent dispute resolution’ to secure the benefits of foreign investment; ‘Policies that encourage product innovation and the creation of new firms, along with policies and laws to protect market contestability, help mitigate security risks’ by delivering superior market structures; and building ‘strong defences in firms and organisations against cyberattacks and enforcement of strong laws against cyberattacks.’

The Grattan Institute has some suggestions for Australian political reform, focused on campaign spending, donations and political advertising.

Sergey Alexeev looks at the effects of home ownership on intergenerational income mobility in the United States, Germany and Australia.

FT Aphaville with a cautionary story about the financial costs incurred by paying too much attention to economic Cassandras.

Bloomberg’s Noah Smith explores the causes and consequences of the abundance of financial capital in the global economy, including a ‘flood of investment dollars into high-profile projects with low expected returns, such as WeWork’.

Sam Roggeveen and George Megalogenis discuss the argument behind Roggeveen’s Our very own Brexit, which explores the uncertain future of Australia’s political duopoly and asks whether one – worst case – consequence of this political ‘hollowing out’ could be our own ‘Brexit moment’ in the form of a radical turn away from immigration that would distance Australia from Asia in the way that Brexit may distance the UK from Continental Europe. (There’s an abbreviated transcript at the link, but you have to listen to the podcast to get the full conversation.)

An IMF paper examines the drivers, implications and outlook for China’s shrinking current account surplus. After peaking in 2008, the past decade has seen a dramatic decline in the surplus along with some major compositional changes: outbound tourism has created a deficit in services trade; the income balance has turned negative despite China being a net creditor; and the goods surplus has fallen. The authors reckon some of this is cyclical but that the trend decline has mostly been structural, reflecting the rebalancing of the Chinese economy, real exchange rate appreciation and market saturation overseas.

Chatham House on US-China competition for global technological supremacy. The paper – actually a collection of related essays – argues that the underlying driver of the current trade war between Washington and Beijing is not the bilateral trade imbalance or accusations of currency manipulation but ‘a race for technology dominance.’

The Atlantic Council updates its work on Global Risks 2035, originally published in 2016. The headline judgement of the new assessment is that in the following two years, ‘the post-Cold War order has continued to unravel without a “new normal” emerging. If anything, with de-globalisation underway, conflict among the great powers looms even larger…’.

An Observer special report on Europe’s megacities which reflects on the success of the post-industrial city based on ‘the clustering of high-end services in the great metropolises’ and the consequent economic and social divides that have contributed to the rising importance of the ‘politics of place’.

The US Council on Foreign Relations provides a short brief on political developments in Bolivia. Related, an overview of the current unrest sweeping Latin America. One diagnosis, advanced by the Peterson Institute’s Monica de Bolle, is that the current situation is ‘a product of the “post commodity boom syndrome,” that is, the crushing of hopes for prosperity that had been engendered by the 2004–14 period of rising commodity prices, which had lulled the people of Latin America into a false sense of security about their economic future.’

A while back I linked to a discussion with Andrew McAfee on dematerialisation. This FT book review contrasts MacAfee’s new book with a very different take from Vaclav Smil.

Another podcast: this one is a conversation between Ivan Krastev and Timothy Garton Ash on Eastern Europe ten years on from the fall of the Berlin Wall, looking at how and why Western hopes for the region haven’t turned out quite as expected. For an earlier (written) taste of Krastev’s thinking, see this piece on the unravelling of the post-1989 order.