Key insights from the week that was.
In Australia, the data release of the week was the January Labour Force Survey which reported a +17.8k lift in employment, in line with the market’s expectation. While labour demand is still best characterised as ‘soft’, having slowed to a well below-average pace through 2025, it appears to be finding its footing. At the same time, labour force growth has been tracking a weaker trend, the participation rate falling 0.6ppts over the past year, keeping the unemployment rate steady at 4.1% in recent months.
This data is likely to raise some concern over a possible ‘re-tightening’ in labour market conditions, and the risk of more persistent inflation – a key concern for the RBA’s Monetary Policy Board. On the latter, Chief Economist Luci Ellis dissected the minutes from the February Board meeting earlier this week, including the apparent downplaying of the impact of exogenous exchange rate appreciation on the inflation outlook.
Coming back to the labour market, it is important to recognise that a lower unemployment rate has a very different flavour if it is being driven by weaker participation versus stronger hiring. The forces driving the current downswing in participation – namely an easing in cost-of-living pressures – may not persist for much longer given inflation’s persistence. Combined with an underlying structural uptrend in labour supply, we could easily see a turnaround in labour force participation lift the unemployment rate again.
This is all to say that the upside risks to inflation stemming from the labour market may prove transitory. This week’s benign result for Q4 wages growth, up 0.8% (3.4%yr), supports this assertion. Today’s note from Chief Economist Luci Ellis furthers the discussion around the relationship between the labour market and inflation.
Offshore, in a holiday shortened week, the focus was on the balance of risks in the US. Out last Friday, the market celebrated January’s 0.2% headline gain for consumer prices against the 0.3% consensus expectation. However, the headline beat was primarily the result of a 1.5% decline in energy prices and a moderate 0.2% increase in food prices, along with a flat outcome for core goods prices. Services ex-energy in contrast rose 0.4% in January after a 0.3% increase in December – outcomes well in excess of the FOMC’s target and consistent with broad-based capacity pressures across housing, transport and medical care.
While the January FOMC meeting occurred before this data release, the minutes recognised that inflation risks are now broadly balanced against labour market uncertainty, which has receded of late given evidence of stabilisation after a period of “gradual cooling”.
Arguably, most of the Committee still believe policy can be eased further in time, but it is interesting to note that “Several participants indicated that they would have supported a two-sided description of the Committee’s future interest rate decisions, reflecting the possibility that upward adjustments to the target range for the federal funds rate could be appropriate if inflation remains at above-target levels”. So, if we see further persistence in services inflation, or businesses pass through more of the cost of tariffs, the FOMC may become more vocal in their concerns over inflation. This would trigger a resetting of market expectations from the current pricing of two or more cuts in 2026 to one or no cuts, with consequences for financial markets.
We currently view one fed funds rate cut as most probable in 2026, although this view is held with low conviction given the above risks to inflation. For the US dollar however, we continue to believe any rate reset is likely to be more than offset by a greater appreciation of growth opportunities elsewhere in the world, seeing the US dollar trend lower.
Across the Atlantic, Q4 GDP disappointed in the UK (0.1%, 1.0%yr) but showed resilience in the Euro Area (0.3%, 1.3%yr). Thankfully for the UK, the latest inflation data gave the BoE support to continue cutting through the first half of this year as annual headline inflation slowed to 3.0%yr, to be in line with core inflation at 3.1%yr. Importantly, services inflation looks to be abating as hoped, now 4.4%yr after being stuck around 5.0%yr through the first half of 2025.
Turning finally to Asia, we are yet to get a sense of how China’s economy has begun 2026 given Lunar New Year Holidays but expect authorities will have to quickly shift to a pro-active stance for policy, else risk a structural deceleration in growth taking root. Across the rest of the region are a broad array of conditions and prospects, with countries such as Taiwan and Vietnam growing rapidly while those whose industry is concentrated more in services such as Thailand underperform. Politics are also very important at present and likely to remain so. As an example, the opportunity seen by many in Japan’s economy and stock market depends on the Government taking action to support investment and consumption and, in doing so, spur private sector confidence. Highlighting the need for action, this week Japanese Q4 GDP surprised to the downside, rising just 0.1% after a 0.7% decline in Q3. Underlying the result, household consumption grew just 0.1%.
