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Australia’s Unemployment and Inflation Conundrum

James Boston
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The Australian Dollar is showing some signs of strength ahead of this week’s Reserve Bank of Australia (RBA) monetary policy meeting. Recent soft economic data will likely encourage the policy makers to continue holding fire on the previously expected interest rate hike.

Markets are betting that the RBA will leave the official cash rate at 2.5% despite rhetoric following last months meeting putting investors on notice of an impending adjustment.

Australia’s employment situation has taken an unexpected negative turn. January’s unemployment rate of 6.0% was a reversal from the December low of 5.8%. There were some adjustments to how the labor participation rates were calculated, so it is likely that the rise in fact greater than 0.2%. Regardless of the pace of change in the unemployment rate it is the surprise element of the rise that will be encouraging the RBA to rethink their monetary strategy.

Weakness in the Aussie Dollar has proven good for trade balances, this however is beginning to manifest as upward pressure on domestic prices. The RBA will no doubt consider the inflation situation during it’s deliberations at tomorrows meeting. A recent jump in the CPI from 2.2% to 2.7% will cause some concerns for the policy makers.

The RBA is now facing the unenviable challenge of battling rising unemployment with rising inflation. Australia however has historically been resilient to inflation, unlike most developed economies that see 2% as an upward ceiling for the rate of price rises, Australia’s long term inflation rate has averaged around 2.75%.

This buys some breathing space for Australia’s policy makers. The path through this current economic challenge is clear. Triage is required. Deal with the unemployment situation first and revisit the inflation situation when the core economy begins to show some stability. If the RBA take this course then we can expect interest rates to be held at current levels for next few months with talk of a hike coming only after the data starts to improve.

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