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More workers, lower interest rates?

12:57pm October 22 2019

Workforce participation has risen over time as people stay in the labour market longer. (Getty)

As interest rates have headed lower, debate about the impact on Australians with savings has only gotten louder. 

It’s not surprising – this month’s cut in the cash rate to 0.75 per cent, the third reduction since June, makes the days of a cash rate north of 7 per cent prior to the depths of the global financial crisis seem like a very distant dream. Yet the ensuing low – or negligible – real returns on cash are very much a reality.  

And what if this dynamic could actually be playing a role in what is forcing rates to continue to fall? 

Answering this question requires zeroing in on participation in the workforce by age cohort, in particular the older generation. 

Despite the modest decline in overall participation seen in this month’s labour report, it has risen to around the highest levels ever in recent times. This has made the RBA’s goal of reaching full employment harder as the pool of available workers expands and Governor Philip Lowe has put the emphasis on the increase in working females, but also older Australians. 

Zooming in on the last year, we can see that while the lift in participation has been broad-based (by age and gender) there is a skew towards the older age brackets, especially those aged over 65.

For the 45-54 category, we can see that this follows a lift in the 35-44 category in 2017. Both groups make up a large chunk of the “mortgage-belt” servicing home loans and have experienced a gradual rise in participation over time, largely driven by more females in the workforce. This is in part due to the continued generational change in attitudes and preferences, but, more recently, is also likely due to needs for higher household incomes given the rise in house prices and other living costs over time. 

For the older 65-plus category either eyeing retirement or already there, participation is accelerating over and above the broader structural uptrend relating to improved health outcomes which emerged in 2005 from a low base. In the decade leading up to 2017, the size of the labour force increased by a relatively steady amount of around 25,000 per year. 

But since then, it’s rapidly shifted higher to a pace of around 55,000 per year. First, participation jumped for males in 2017, and was followed by a similar lift in females at the start of 2019. 

Put simply, people are living longer.

In many ways, this is a good thing for the economy. More hands working means higher output and an overall richer economy. But conversely, higher participation is actually one of the drivers behind the RBA’s rate cuts.

This is because we have spare capacity in the labour market and higher participation makes it harder for the RBA to achieve its ambitious task of lowering unemployment from 5.2 per cent to 4.5 per cent (the level estimated to be full employment) to boost wages growth and hit their inflation target of 2-3 per cent. 

But what if low rates are in part a cause of spare capacity and not just a solution?

Older Australians face significant longevity risk and a lower rate of return on their investments means their savings will not go as far. 

While higher asset prices have helped some people, when planning for retirement it was unlikely that many (if any) were anticipating near-zero interest rates. 

Consequently, the recent lift in older age participation is likely in part related to a need to postpone retirement to meet savings goals.

That does not necessarily mean monetary policy has become counterproductive -- there are other channels that are likely to be more than offsetting such as the impact on borrowers and the currency. 

But it does highlight that with rates already so low, further cash rate cuts are becoming less effective due to a number of factors, of which, higher older age participation is one. As the minutes to this month’s board meeting showed, the RBA is alert to some of these factors but decided on balance that a rate cut would nevertheless support reducing spare capacity in the economy.

We continue to expect the RBA isn’t done yet, forecasting another 25 basis point cut in February. 

This material contains general commentary, and market colour. This material does not constitute investment advice. This information has been prepared without taking account of your objectives, financial situation or needs. We recommend that you seek your own independent legal or financial advice before proceeding with any investment decision. Whilst every effort has been taken to ensure that the assumptions on which the forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The ultimate outcomes may differ substantially from these forecasts. Except where contrary to law, Westpac and its related entities intend by this notice to exclude liability for this information.

Simon is an Economist at Westpac. His areas of research are Europe and the UK, linkages between the financial sector and the broader real economy, as well as varying project work on the Australian economy. Simon joined the Westpac Economics team in 2017 and is a CFA® charterholder.

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