RBA Governor Glenn Stevens is probably looking at the recent economic news in a Lara Bingle kind of way – ‘where the bloody hell are we?’
This week there has been some schizophrenic news with solid gains in business confidence and consumer sentiment, yet a second straight month of falling employment with the unemployment rate hitting a new four-year high of 5.8 per cent. This follows recent news of a solid, albeit slightly below trend, growth pace for GDP and ongoing low inflation.
It pays to remember a couple of vital things when looking at divergent economic news. It is never the case that every indicator is pointing in the same direction and with the same momentum. Even in the strongest upswing or deepest downturn, there are often a few ups that are accompanied by a few downs. Some of the ups will be strongly positive and some will be less robust. It is the way economies normally perform.
What is also critical to recall is the difference between leading and lagging indicators for the economy.
Leading indicators are those which usually turn a little before or ahead of the general business cycle. Share prices, bond yields, housing and even consumer sentiment often (but not always) turn before the whole economy adjusts and then move in the same direction. Lagging indicators are so named because they do not change their direction or momentum until many months after the business cycle has turned. The two most important lagging indicators are employment and inflation which only pick up after the pace of economic growth has accelerated and vice versa.
Yet it is employment and the rate of inflation that attract a lot of the attention each month or quarter. Yesterday’s jobs report was no different.
The RBA’s Stevens will be delighted that the leading indicators remain solidly positive and will not be concerned that the lagging indicators remaining soft.
Importantly, there is a quite massive wealth effect unfolding for consumers with house pricing rising at a solid pace and the stock market hitting fresh five-year highs. The value of the ASX and house prices has increased by over $700 billion in the last 18 months or so. That is a lot of wealth that has been generated. Add to that a clear uptrend in housing construction and the lift in the animal spirits for business and consumer and there are reasons to be optimistic about the outlook. Clear signs of an upswing in the global economy bodes well for ongoing strength in exports.
For some time now, Treasury, the RBA and the bulk of market economists have been forecasting a lift in the unemployment rate. The more optimistic forecasts are for the unemployment rate to rise to 6 per cent while the more gloomy are looking for 6.5 per cent or more. Treasury is in the middle with a forecast for the unemployment rate to peak at 6.25 per cent.
This is the context for yesterday’s jobs numbers which showed a second month of falling employment and a further tick higher in the unemployment rate, to a four-year high of 5.8 per cent.
On a best case, it is still likely that the unemployment rate will rise in the next few months. This should not be a concern for the economy or Glenn Stevens for that matter so long as the leading indicators keep their positive glow.
To be sure, the labour force data yesterday were not good, but nor were they unexpected. While the Australian dollar fell sharply in reaction to the news and the odds for a further interest rate cut shortened a little, the leading indicators that remain solidly positive and will likely stop the RBA from cutting interest rates any further in the current cycle.
Thankfully, Mr Stevens is no Lara Bingle. He understands where the economy is at and can decipher the important news from the noise, and the leading indicators from the lagging indicators.
For now, he will be broadly content with the way the economy is performing. Stevens will likely enjoy the footy finals and perhaps a little flying time over the next few weeks in full knowledge that there is a huge amount of monetary stimulus in place and because the leading indicators for the economy are looking stronger than they did a couple of months ago.