As the Reserve Bank of Australia (RBA) again kept rates on hold in August 2021, TPT Wealth warns the labour market will have to tighten further and wage growth rise significantly before investors see cash rate increase.

TPT Wealth’s Senior Investment Manager, Jukka Viljanmaa, said following the July RBA meeting, the RBA reported the labour market would need to be tight enough to generate materially higher than the current wages growth before it would increase the cash rate.

The RBA said its central scenario for the economy was that this condition would not be met before 2024.

Mr Viljanmaa said this represented a subtle but significant change in language and after a series of stronger than expected labour force survey numbers estimating employment, the Bank had given itself some timing options for its first cash rate increase.

“The market reaction to the RBA statement priced the first 25 basis point increase in the cash rate for September 2022, with the cash rate target reaching 1.75 percent by June 2025,” he said.

“Whether this happens sooner or later will not only depend on the data but also how events play out during the unusual times we currently live in with COVID-19.

“A key condition for the RBA to raise the cash rate target requires the labour market to continue to generate employment growth, and it is likely wages growth will need to exceed three percent. The Board believes unemployment must fall to below four percent to generate this level of wage inflation.”

Mr Viljanmaa said the make-up of the Australian employment market had changed over the past 15 months and the recurring COVID-19 lockdowns were also having an impact.

“The number of Australians unemployed decreased by 303,700 from June 2020 to June 2021, however some 300,000 non-resident visa holders have left Australia due to Covid-19. Australian residents have been employed in their place with borders remaining closed.

“The RBA recognises that when borders reopen there will potentially be an influx of labour. Further, the underemployment rate stands at 7.9 percent, indicating people who are prepared to work more hours and presumably at the same wage.

“Certainly, the employment market is currently showing strength with June data indicating an unemployment rate of 4.9 percent. But it will need to fall to below four percent with associated wages growth before we see a material rise in interest rates.

“But as the RBA has pointed out this level of wages growth has only happened once over the past 40 years, so the hurdle has been set at a high level.”

Mr Viljanmaa said historically the RBA would increase the cash rate target when its forecast for inflation was within the two to three percent band.

“However, in a significant shift it now wants to see actual inflation within that band on a sustainable basis. While there is currently strong momentum in economic growth and employment, how events play out, particularly national and international borders reopening, will determine when the RBA increases the cash rate target,” he said.

The views and opinions expressed are presented for informational purposes only and are a reflection of the best judgement at the time the content was compiled by the Senior Investment Manager, TPT Wealth.