(Bloomberg) -- Australian employment unexpectedly dropped in July, giving the Reserve Bank scope for a more flexible approach in its tightening cycle.

The economy shed 40,900 roles from a month earlier, confounding expectations for a 25,000 gain, statistics bureau data showed Thursday. The surprise reduction sent the Australian dollar and government bond yields lower.

The report also showed unemployment fell to 3.4%, a 48-year low, as the participation rate declined. The latter reflected floods along the nation’s east coast, a renewed Covid outbreak and school holidays that all discouraged job hunters.

Cross-currents in Australia’s labor market combined with weaker than expected wages data on Wednesday might give the RBA the option of returning to quarter-percentage point interest-rate increases after three straight half-point hikes. The bank reiterated this week that it isn’t on a pre-set path.

“Covid has created more variability in employment during school holidays recently,” said Diana Mousina, senior economist at AMP Capital Markets. “So the weakness in employment growth is probably somewhat overstated.”

Most economists expect the RBA will shrug off the unexpected decline in the often volatile jobs report and execute a fourth half-point hike in September to bring the cash rate to 2.35%.

“But the risk of a 25 basis point hike is very high,” added Mousina. “The central bank could also consider a 40 basis-point increase which would signal that it is slowing its pace of tightening.”

Overnight-indexed swaps also imply a 40-basis-point hike to 2.25% next month.

Today’s data defied private business surveys that show the economy is operating near full capacity. Job vacancies are hovering around record highs and the RBA forecasts unemployment will fall further. 

What Bloomberg Economics Says...

“The reopening of the international border has led to a surge in net migration, boosting working-age population growth. A major turnaround in the labor supply could have a significant impact on labor-market dynamics once disruptions subside.”

--James McIntyre, economist

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Australia’s tight labor market has so far failed to drive a significant jump in wage growth. Figures Wednesday showed the wage price index grew 2.6%, less than half the pace of inflation. 

Treasurer Jim Chalmers is focused on driving higher wages and productivity gains and has announced a ‘Jobs & Skills Summit’ next month.

“Wages are starting to pick up but not nearly as much as inflation, which is eating into living standards,” Chalmers told reporters after the wages report.

Today’s jobs report also showed:

  • The labor force participation rate -- the share of the population that is working or looking for jobs -- fell to 66.4% from 66.8%
  • The jobless rate is the lowest since August 1974
  • Underemployment fell 0.1 percentage point to 6% and underutilization also declined to 9.4%
  • Full-time roles led the decline, dropping by 86,900, while part-time positions climbed by 46,000
  • Monthly hours worked decreased by 0.8%

“It’d be easy to view the July decline as a sign that cracks are beginning to show across the Australian labor market,” said Callam Pickering, an economist at global jobs website Indeed Inc. 

“That seems premature given that forward-looking measures of labor demand, such as job vacancies, remain incredibly high.”

(Adds comments from economists.)

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