Transcript of Question & Answer Session Cyclical and Structural Changes in the Labour Market

Thank you, Steven Walters, JP Morgan. Chris, thanks for your comments there. I'm just interested: a couple of months ago when the Bank seemingly changed the tone of the comments around the labour market and I think most would agree the comments became slightly more upbeat. I'm just wondering what really drove the change? Was it the leading indicators evolving in a different way or am I correct in saying that the Bank changed its view a couple of months ago? Because I remember you talking — or the bank talking —about unemployment perhaps only continuing to rise, but I think you just repeated the phrase that it would stay pretty constant before starting next year, so I'm just interested in your views around that.

Yeah so, I mean, as always with our forecasts there's quite a lot of uncertainty around them. I think what was happening over the course of this year is more hard data on actual labour market outcomes, if you like. Employment in particular coming to light, as well as the drop in the unemployment rate: it's dropped a little bit since February this year. That perhaps wasn't so surprising. We saw, as I showed earlier, some improvement in, or we've certainly seen an improvement in GDP, but more importantly the sort of more labour intensive non-mining activity just started to pick up across a range of indicators and then subsequently the labour market showed these signs of improvement. Employment growth has been relatively strong over the course of this year, but as I said I think part of that reflects this improvement, but part of it may also be that just the growth in employment in heads terms that we'd seen right through 2013 was really surprisingly weak given that demand growth wasn't that subdued. It was moderate, but it wasn't that subdued. So there may just be an element of catching up there. And finally the thing to say here is that yes the forward-looking indicators have improved, some of them have improved more than others, and that's positive, but they remain at pretty low levels. So they're still consistent with only moderate employment growth over the period ahead and that's what our forecasts have. With the population growing still pretty strongly and therefore the labour force growing still pretty strongly, that means the unemployment rate should stay elevated for a time.

Labour market flexibility is a big public policy issue and it has been for a long time, and still seems to be. From what I've heard, you saying how the Bank's written up things in recent times, and the way that the labour market's reacting to economic news, it seems that the labour market already has a fair degree of flexibility. Softer growth we've seen, unemployment fractioning up and wages growth slowing. Do you think labour market flexibility is pretty good at the moment, and that's another benefit for our economy, that we've got a reasonably flexible labour market?

It's a good question. You know I've done work trying to measure that, and it's extremely hard to measure and very hard to compare to what's happening in other countries as well. I think the point that we've made about labour market flexibility is really a comparison to much earlier episodes. So this is a flexibility that's sort of developed over quite a period of time, really starting from something like the 1990s onwards. And it's not just any one particular policy, but quite the sort of the accretion of all of these. But what it meant was you could get a big increase in the demand for labour in the resource sector during the big expansionary phase in mining investment, and wages there could pick up, but they wouldn't automatically just translate into it the same sort of wage increases right across the economy, and generally people didn't then just lift their inflation expectations, their expectations of wages everywhere. There was some lifting of wage growth elsewhere, but it was pretty moderate in the scheme of previous expansions and I think what that did was even though we've had a rise in a nominal unit labour costs relative to the rest of the world, presumably that's much less than what we might have got in much previous episodes which didn't end so well.

The optimist in me would say yes, and the pessimist in me would say no. So I think you're right, it may well have a cyclical element. The point of this chart, it's a little hard to see in the lines, that's why we've put some numbers here for you, so the total economy growth is about 2 per cent per annum over the latter part, the last few years shown there on average. Now some of that is definitely coming from mining, because if you exclude mining it's not as much. But both at notably higher growth rates than that period from the mid 2000s. So there may be a cyclical element to it, it's always hard to know this data itself is subject to revision and what really matters is whether this will be enduring. And I don't know, I think you can see the sorts of competitive pressures that are coming to bear, including for some time in the non-mining parts of the economy through the high exchange rate, that's the sort of thing that can lead firms particularly, to try and do the things they need to do to get productivity up. Whether that's going to be sustainable I don't know at this stage. I think we've got a few years here though, so it's positive, but it's too early to say. What it does do in the chart, at least it suggests that the anomaly, if anything was that sort of middle period. So it's an open question I don't know yet is the answer.

Yeah well, I think as you said, the mining part, the direct part on that last bar there, that looks from this other graph to have peaked. It looks to have plateaued for a while, but more importantly as you suggest, it's this related activity in other parts, and you can see perhaps the strongest suggestion of that in businesses services which have fallen quite a bit. Our own liaison suggests that firms in that sector that affected and directly connected to that mining related investment activity, they think much of that sort of reasonably sharp pull back has sort of run its course, that's hard to know for sure and it's going to vary a bit I think from one commodity to the next. But that's the sense overall that much of that has occurred, but we know there are workers, particularly on some of these big LNG projects for example, and they use a lot more workers to build the thing, and they're still in the building phase. They need to run them when they're in their operational phase. So I think there's still more of that to come, so it's a little hard to know, but some more to come, may be not quite as much as we've seen, but still some significant reductions perhaps. Depends of course on commodity prices, so some are weaker than others at the moment, coal in particular for example.

I might put you in the same chart, it seems that you know one the reasons perhaps unemployment hasn't risen quite as fast as was expected, because we've seen a substantial pickup in employment in the non-mining construction sector, despite that construction has responded appropriately to the signals from house prices in particular. More so perhaps than in previous house price strength, but we are seeing some signs. If you look at the data suggesting house price inflation is starting to moderate quite substantially in the last couple of months. And building approvals numbers suggest that building approvals might be starting to moderate and quite quickly. So is there any concern about whether either the construction sector might not be able to absorb and work has been shed from the mining construction side as readily perhaps as it looked like a couple of months ago?

It's a good question. So I think it's still an open question. We're definitely facing a period of reasonable strength in building activity in both residential and non-residential building sectors over the next year or so. We see that in the building approvals of both, they've been elevated for a while and so the work that's yet to be done, the work in the pipeline: that's been building to reasonable levels. So there is a demand for labour there, maybe we're seeing the early signs of some of that labour being employed in that sector to do that work. The thing about whether or not that's going to be sufficient and useful in terms of absorbing this labour being freed up from the mining investment-related activity, the mining construction, is whether or not those skills are transferrable and whether those people are transferrable. Our sense is that definitely, non-residential construction, many of those skills are can be used in both (obviously not all). It's also true of much of the dwelling investment, because remember a lot of the dwelling investments are in the higher density space, rather than the detached dwellings. So the detached dwellings is where we understand those skills aren't as transferrable, but there is, thankfully perhaps, a lot more of those building approvals in the dwelling space as being in the high density, and then there's those non-residential building approvals. Which have been running at a pace which has led to a build-up in the work yet to be done, so that's the period in the next year, but I think it's still an open question as to whether or not the labour can move, and whether that demand will offset what's let go from the mining side of things.

Thank you Chris for your talk. A little similar line, I guess it's a question about the weakness in wages growth, whether you saw the weakness was so pronounced in wages growth that it was going to undermine the strength of consumer spending, so it already seems that we had just a very brief burst of consumer spending, wages growth and labour income has really cut right back and we just haven't seen a lot of momentum going into the second quarter of this year?

I mean I think it's been true that wages growth has been moderate for some time now and so that in itself has led to slower growth of household disposable income than otherwise, as well as, at least through 2013, the reasonably weak growth of employment. So, on the one hand wages growth doesn't look like it's done anything much different in the last little while, from what it's been doing recently, so it's still pretty low, but employment for the first few months of this year at least has picked up. Well that's going to boost household incomes. I think what our forecasts assume for consumption is that there will be some wealth effect, which will lead to a slight, and I say a slight decline in the savings ratio, so you can get consumption running a little bit faster than incomes, if the saving ratio is dipping just a little bit. We're seeing that savings rate dip for the better part of about 18 months, it's just been a slow trend down, our forecasts have a little bit more of that. So that should help to keep consumption growth above income growth. You're right, retail sales for example have sort of softened a bit in recent months, but that comes after a very, very strong January and it's often the pattern that we've been seeing. So I think it's still an open question as to sort of how that should proceed. But I think the main theme is wages growth remaining low, we don't see it falling from here, the indicators don't suggest that but neither does it look like it's going to pick up any time quickly. There's been some improvement in the labour market in terms of employment, that's very welcomed, that should help support consumption at the margins, as will this sort of wealth effect from house prices, equity prices as well.

Well I think it's an open question and it was the point of, I'll see if I can find it, of this chart. We just don't know whether or not this earlier trend rise in, say, participation of older workers, whether the plateauing of that, and even turning down just a little there for males, is something that's occurred just because growth's been a bit slower than previously and you've got this discouraged worker effect weighing on that. Or whether there is, as I said, maybe things like rising longevity and so on have run up against the sort of current incentives that many people face to retire at a particular age. And so, even though we'll be living a bit longer and in reasonably healthy form, maybe we still have this incentive to retire. So we just, I think, we don't know. What we do know though is that the effect, the direct effect of aging or participation, that's building a bit, and it's reasonably noticeable and these are slow-moving things, but in time I just see that that could be an important influence and that will sort of weigh on participation. And so if that's the case they would have an aging population in retirement, you know the demand for labour – the weak demand for labour won't be so much the issue as a weaker supply for labour. But it's rather speculative … I don't know. I wrote a paper on this back in 2006 suggesting this was the case and it was just alluding to that possibility.

To your comment on the Aussie dollar and commodity prices, which you noted they were quite divergent at the moment. And when I look at the two on a chart it almost looks like they're even more divergent, say compared to say fourth quarter last year when you guys were quite vocal about the setting of evaluation of the currency. Are you now – I mean you guys have said less about the currency so far this year, are you more accepting of that divergence in the sense that when you look around and you see the Bank of Japan continuing to expand its balance sheet and the ECB seemingly expressing a desire to do the same thing, these are sort of unusual conditions which would maybe tell you that that divergence will persist for a lot longer than you would like. Is that the reason why you guys have appeared at least in the service to be a little bit more comfortable?

I wouldn't use the word to describe it like that, I would say, and we've said on numerous occasions that we think it's high, and in part largely because of that further fall in commodity prices, as you said since around February, the exchange rate has been moving up and commodity prices have been moving down in a noticeable fashion. And in February I gave a speech shortly after we put the statement out talking about the exchange rate and how I think about it at least. And the thing is it can really diverge from these fundamental levels for quite a while, and it's really hard to know exactly why, and those fundamental levels depend most significantly in a statistical sense at least, on things like the terms of trade and commodity prices. The interest rate differential has a bit of a role to play, so commodity prices that are the real sort of statistically significant explanator over a long period of time. So we say it's high at the moment, I think that's a reflection of the fact that its moved higher since February while commodity prices have moved the other way. That's not a forecast because the other thing about my speech is you can't forecast the nominal exchange rate, but the models tell me that we shouldn't be surprised if the exchange rate was to fall further from here because of those commodity prices, and what they're doing. I don't know, as you said the exchange rate depends on a range of things, including what's happening off shore.