Hard labour

06 July 2011

One of the major concerns in the outlook for the Australian economy is how the economy balances the strength of the booming mining sector, with the slowing in household demand.  In this respect, recent weaker employment growth suggests that this balance may have shifted.  

But just as concerning is the weakness in leading indicators of employment.  In particular, the Purchasing Managers Index (PMI) data for a range of sectors shows a consistent decline in surveyed employment expectations for the construction, services and manufacturing industries.  

In this note, we highlight that if employment growth continues to fall, it would be an indication that weakness in these sectors is overpowering strength in the mining sector.  And in that environment it would become a lot harder to argue for higher interest rates.

The emergence of a two-speed economy has made it increasingly difficult to assess the true strength – or weakness – of underlying economic conditions in Australia.  Total GDP growth obviously provides a gauge of overall demand/output, but by the time it is released each quarter, the information is already quite dated.  As a result, we think it is more useful to look at the key labour market indicators for a timelier and more frequent barometer on how overall economic conditions are evolving.

There is little doubt that employment growth has slowed since late last year.  In the past six months, a net 30 000 jobs have been created in Australia, compared to the 228 000 net jobs increase recorded in the six months prior.  Of course, this has coincided with the devastating summer floods and the resultant sharp fall in economic output, and this could mean that the sharp deceleration in employment growth was only temporary.

In our opinion, however, this slowing is likely to be a persistent issue over the remainder of the year, given that the softer parts of the economy are actually getting weaker.  This is most evident in the leading indicators of employment, which are showing a consistent story of weaker demand for labour across a broad range of industry sectors, such as retail, manufacturing and construction.

These sectors make up a far larger portion of the Australian labour force, compared to those areas that are expanding, namely mining and agriculture.  And, based on indicators such as the PMI surveys, business surveys and job vacancies, we expect to see a further moderation in employment growth over the next six months.

The NAB monthly business survey’s index of employment intentions is pointing to a gradual moderation in employment growth – albeit at a solid pace – over the next six months.

Within this estimate however, are very strong expectations for mining sector employment, offsetting weakness in other key sectors.

So, given that economic conditions vary greatly between sectors, it is useful to look at how employment expectations are changing within different sectors.  This is because – similar to capital spending plans – while mining sector employment intentions are undoubtedly strong, there is a limit to how much this sector (which accounts for only two per cent of total employment) can add to jobs growth alone.  

This is particularly the case given that there are a large number of firms in other industries pointing to far weaker employment plans.  This is most evident in the range of PMI surveys, which measure activity in the services, manufacturing and construction sectors.  Together, these three broad sectors account for around 70 per cent of total employment in the economy.

Within the services sector, it is those firms that are exposed to household spending that are reporting the largest declines in employment.  This is consistent with the recent weakness in retail sales and the negative effect of the high A$ on the tourism and hospitality sector.

The high A$ has also been cited as a key reason behind weakness in the manufacturing sector, which recorded its seventh consecutive month of declining employment in May.  To be sure, the manufacturing sector has been shrinking as a share of the Australian labour force for some time, but it is still responsible for nine per cent of total employment and so movements within the sector can have a noticeable impact on overall jobs growth.

One of the more surprising results in the PMI surveys comes from the Performance of Construction Index, which shows that the construction sector is recording the weakest levels of activity.  This extends to employment within the sector, which has reportedly been falling for the past 12 consecutive months.  To be sure, this is consistent with the weakness in housing and non-residential building, but given that this index also includes the engineering sub-sector, we would have expected to see some improvement in employment as a result of the very strong mining investment plans.

This could be one indication that the weakness in the non-mining economy is having a greater influence on the labour market than the booming mining sector.

The key point is that despite the anticipated surge in resources investment, employment growth will still slow if these weaker sectors continue to weaken.  If that does occur, it will be an indication that the balance in the economy is shifting towards to the weaker industries, and in that kind of environment it becomes a lot more difficult to argue the case for higher interest rates.