MNI: RBA Likely To Hike, Labour Market To Fuel Caution

The Reserve Bank of Australia is likely to lift the cash rate from 3.85% at least once more, but will adopt a cautious approach to any further tightening as it assesses the impact of restrictive policy on the labour market, former staffers told MNI, with dynamics such as participation rates fuelling debate and allowing competing narratives around underlying labour market strength.

Falling participation and weak job creation, particularly in New South Wales, are likely masking a looser labour market and should warrant greater caution from policymakers, said Blair Chapman, senior economist at Seek and former RBA research economist, despite recent communications emphasising tighter conditions.

Employment growth in 2025 was the slowest since 2016 despite population growth of 1.8%, highlighting subdued job creation that appears at odds with the RBA’s “tight” labour market narrative, he argued. An unwind in participation, particularly among university-aged workers where participation had reached a record high, could make the market appear tight even as slack persists, he said.

“We saw this at the start of the 2000s, when the unemployment rate made it look tight but the participation rate was dropping. So [the RBA] has to watch both,” he said.

Victoria recorded the highest unemployment rate in the country in December, 40 basis points above the national average at 4.5%, but participation dropped 30bp to 67.7%, Chapman noted.

However, Tim Robinson, senior research fellow at the Melbourne Institute and former RBA economist, said that while participation has eased from a year ago, it remains high by historical standards.

“In my opinion, caution from the participation rate falling may be about subsequent increases rather than the first,” he said, citing Westpac research suggesting cost-of-living pressures contributed both to its rise and its subsequent easing.

RBA’S EVOLVING VIEW

Chapman said a recent labour market presentation by Assistant Governor Sarah Hunter did not sufficiently address easing participation, despite outlining how the Bank is incorporating broader indicators including participation, as well as hours worked per capita and vacancies-to-search ratios, rather than relying solely on historical averages or the unemployment rate.

While Hunter’s presentation showed the RBA has refined its approach to assessing labour market conditions, Chapman said the shift, though overdue, is unlikely to alter its reaction function, which still relies heavily on unemployment and inflation metrics.

Overall, while parts of the economy appear balanced or slightly tight, weak employment growth and softer participation suggest some underlying slack, he argued. Policymakers should remain mindful of this, though inflation remains the primary concern, he added.

However, Robinson said Hunter’s speech struck a slightly hawkish tone and provided substantial justification for February’s increase. “While temporary factors are contributing to inflation, some tightness in the labour market is evident,” he added. 

INTERPRETIVE DATA

Chapman said recent data have been difficult to interpret and could justify either further hikes or a pause, depending on one’s bias. Local council rates, electricity subsidies and Fair Work Commission pay rises have distorted wages and CPI outcomes, he noted. However, the RBA could treat these as one-off factors to look through, strengthening the case for a pause.

“If they don't go again immediately, then I think they're on hold for a prolonged period,” Chapman said, referring to the cash rate. “It's really questionable whether they do go again. Being passive and not doing anything seems easier than being active, and I think the RBA tends to operate that way.”

Markets currently price a 70% probability of a 25bp hike at the May meeting, with the cash rate seen reaching 4.25% by December, implying at least two further increases in 2026. Chapman said February’s rise to 3.85% was necessary to preserve the Bank’s credibility amid persistently high inflation, even if some price pressures were temporary. (See MNI RBA WATCH: Bullock Says Policy Too Loose, Hikes 25BP)

Robinson said another hike is likely. “After that the RBA will be cautious and it depends on how the data evolves," he said. "The strong volumes number from the ABS Monthly Household Spending Indicator points to domestic demand being surprisingly strong in the December quarter."