June labour market data puts pressure on the RBA to cut in August, but …

The labour market report for June was weaker than expected, with employment rising by only 2K over the month (Consensus: +20K), and the unemployment rate lifting to 4.3% from 4.1% (Consensus: 4.1%). The composition of jobs growth was also weak, with full-time employment falling by 38.2K and part-time employment rising by 40.2K. Reflecting this, aggregate hours worked fell by 0.9% in June, taking year-ended growth lower to 1.8% from 3.1%.

No doubt, calls for the Reserve Bank of Australia (RBA) to cut rates imminently will grow louder. An August rate cut would not surprise us given our prior view that the RBA would cut in either July or August, but not both. Money markets are pricing in almost three cuts by the end of 2025. Even so, several factors might encourage the Bank to wait a little longer before easing - and for the doves to temper their expectations.

First, there is statistical noise in the June data. The Australian Bureau of Statistics (ABS) noted a sample rotation bias that pushed the unemployment rate higher. Each month, the ABS rotates an eighth of its data sample out and replaces it with a new eighth. As it turns out, the outgoing rotation group from the May survey has a much lower unemployment rate than the incoming rotation group in June, pushing up the overall unemployment rate for June. Similarly, the outgoing rotation group from the May survey has a much higher full-time employment to population ratio than the incoming rotation group for June, pushing down the overall full-time employment numbers. The ABS advises that these effects could partially unwind in the July release.

Second, credible policy rules do not point to an immediate cut, in fact, some imply hikes. A simple “Taylor Rule” that sums core consumer price index (CPI) inflation (2.7% annualised) and growth in aggregate hours worked (1.8% annualised) points to a short-term equilibrium cash rate. A more complete “Taylor Rule” adds the size of the economy’s output gap (a measure of resource utilisation and a leading indicator of inflation pressure), to an estimate of the long-term neutral rate. Our preferred, real-time measure of the output gap takes an average of National Australia Bank (NAB) business survey capacity utilisation and male full-time equivalent employment, expressed as a share of the “active” labour force. With respect to the labour market inputs into this indicator, we focus on male numbers so that we can focus on the cycle and abstract from the long-term positive impact of women on the workforce. What is interesting is that in June, our real-time output gap measure is up to 0.8% of gross domestic product (GDP) from 0.4%, despite soft June labour market data. A big reason why is that NAB survey capacity utilisation is up very strongly of late and is well above long-term average levels. Another thing to consider is that the rise in part-time workers has also been accompanied by a lengthening of the part-time work week relative to the full-time work week. So even though full-time employment is down, full-time equivalent employment is slightly up, by 8.5K over the month. If the output gap is indeed 0.8% of GDP, this implies an equilibrium cash rate of 4.4%, given our estimate of the long-term neutral rate of 3.6%.

RBA cash rate and simple “Taylor Rule”

Australian real-time output gap

Australian real-time output gap components

Australian real unit labour costs and output gap

Australian 10-year bond yields and neutral rate

RBA cash rate and preferred “Taylor Rule”

Third, while the economy has slowed in Q2, brighter days may lie ahead, with or without further rate cuts. A suite of timely indicators suggests a bottoming out process is underway. Our proprietary financial conditions index (FCI) has eased, driven by a steeper yield curve, improving credit growth, real wage growth and an undervalued currency. Global uncertainty has also receded from its peak (though it remains above normal levels), which should aid private sector confidence. In this environment, productive capacity could tighten or at least remain tight in coming months.

Australian real domestic demand and activity tracker

Australian real GDP and financial conditions index

Historically, the RBA has placed more weight on labour figures than other business surveys. If that pattern holds, we should expect an August rate cut. Yet given supply chain risks and lingering uncertainty about economic momentum, it would be prudent not to ignore what the NAB survey is signalling. Waiting to see whether business capacity tightening persists has merit. If the RBA does indeed cut in August, we would not expect it to endorse the dovish view that two additional cuts will follow by year end.