Stephen Miller
Improved clarity of RBA communications
After a period toward the latter part of 2021 when the RBA communication process seemed to descend into the realm of the confusing, the RBA has injected some clarity in the enunciation of its approach.
After a clumsy conflation of what it had termed ‘outcomes based forward guidance’ (OBFG) with ‘calendar guidance’, it has now largely eschewed the latter and focussed on the former, indicating that if its forecasts of price or wages inflation prove too conservative, then it is “plausible” that there is a policy rate increase this year. That much was suggested by the RBA meeting minutes of its February 1 meeting.
My own view is that the RBA forecasts are firmly rooted in the downside end of the inflation risk continuum and, as such, a policy rate rise is likely around mid-year. Markets have priced in such a scenario and are looking for the policy rate to be around 1.30 per cent by year-end, compared to the current 0.10 per cent. Inflation continues to surprise on the upside, while the arguments for Australian inflation exceptionalism are unconvincing.
The unemployment rate in December was almost as low as it has been at any time since the mid-1970s, validating anecdotes of a very tight labour market. Even if the January numbers released today indicate some small temporary rise in the unemployment rate, the forward indicators of the labour market remain strong.
Accelerating wages can’t be far away if not already here. Importantly, as recently communicated, the RBA process admits the possibility of policy rate increases in 2022, now that it has detached itself from calendar guidance.
Why would Australia be different on inflation?
RBA Governor Philip Lowe maintains, despite increasing evidence to the contrary, that the inflation outlook in Australia is “different”. Of course, there may be some differences in orders of magnitude when it comes to inflation pressure, but not in the fundamentals that determine the direction of such pressures.
Australia is an example of what the textbooks term a ‘small-medium open’ economy. By definition, such economies are ‘price-takers’ with that ‘price’ determined by global forces. Accelerating global inflation – other things equal – means accelerating Australian inflation.
Other arguments for “difference”, such as “increasing globalisation” and “wage inertia” were unconvincing.
How the pressures from “globalisation” in Australia can be different to anywhere else in the “globe” is difficult to fathom. In any case, the political currents on globalisation are running the other way, perhaps, in part, accentuating global inflation pressures.
On “wage inertia”, the argument was that the maintenance of a relatively high participation rate would limit domestic wage growth. It might just as easily be argued that a lower pool of ‘discouraged’ workers in Australia means more proximate wage acceleration here than elsewhere, particularly given the drying up of inward bound migration flows.
The notion of “transitory” inflation is that it doesn’t change wage and price setting behaviour. But there is abounding evidence that these behaviours are changing locally as they have elsewhere: companies feel more confident to increase prices because prices are going up everywhere while workers are naturally seeking higher wages in those areas of the economy where skill shortages are acute.
For these reasons, the “Australia is different” viewpoint is unconvincing.
Why is Australia and New Zealand still alone in the developed world by releasing inflation and wage data on a quarterly cycle?
There is a question relating to the timeliness of the statistical releases the RBA relies (heavily) upon.
The Australian and NZ consumer price index is released quarterly almost four weeks after the conclusion of the relevant quarter. Every other developed economy has a monthly series generally released within two weeks of the relevant month. The Europeans release provisional price data for the Euro area a day or two after the end of the relevant month.
What this means is that the antipodean central banks, in their policy contemplation, are often relying on information that is almost up to 4 months out-of-date, whereas the rest of their developed market counterparts it is in most cases a couple of weeks.
To say the least, this is highly undesirable circumstance given the centrality of inflation to monetary policy calculus.
When it comes to wage data the time lags are even more egregious. The RBA’s favoured wage measure (the wage price index) is released about 1 ¾ months after the relevant quarter, meaning RBA policy contemplation is relying on information almost five months out-of-date. Again, given the centrality of wage growth to RBA deliberations this is also highly undesirable.
As an aside, it might be helpful for the RBA and Australian Bureau of Statistics (ABS) to focus wage measures that include ‘bonuses’ or incentive payments. While differences of late haven’t been that meaningful, such measures are likely to be more obviously pro-cyclical and more indicative of inflation currents than measures that exclude them.
Measures that exclude bonus or incentive payments are likely to be more subject to the “wage inertia” features (both upwards and downwards) that the RBA Governor has referenced.
Paul Keating, as Treasurer, once described the ABS as producing the “Rolls Royce of economic statistics.” And despite the best and very considerable efforts of the men and women at the ABS, that claim is a little hard to sustain today given our relative performance in the area of price and wage statistics. An aged Holden Commodore wagon looks a more apposite analogy.
Perhaps the issue is a lack of resourcing. In which case, the Treasury should provide the ABS the monies for an upgrade, at least to a Lexus standard (hybrid, of course).
The benefits to monetary (and broader) policy formulation demand it.
Overnight: UK, Canada inflation surprise on the upside. No surprises from Fed meeting minutes as US retail sales surge
UK consumer price inflation measures for January released overnight were again higher than already elevated expectations. The UK Consumer Price Index (CPI) rose 5.5 per cent year-on-year in October to register a 30 year high.
The Bank of England (BoE) had expected inflation to remain unchanged at 5.4 per cent. Inflation has now overshot consensus in seven out of the past nine months. Along with figures released earlier in the week that show a tight labour market, including accelerating wage growth, the January inflation numbers may excite expectations of a 50 bp increase in the policy rate when the BoE next meets on March 17.
Markets are “pricing” a policy rate of around 2 per cent by the end of the year compared with the current rate of 0.5 per cent established on February 3.
Markets are already pricing in a half-point increase at one of the next two meetings of the Monetary Policy Committee. Further increases are likely, with current pricing suggesting the benchmark rate, currently 0.5 per cent, will hit 2 per cent this year — the highest since before the financial crisis.
Canadian inflation measures for January were well ahead of expectations with the CPI showing a year-on-year increase of 5.1 per cent versus 4.8 per cent expected (4.3 per cent in core terms versus 4.05 per cent expected).
At its most recent meeting on January 26, the Bank of Canada left the policy rate unchanged at 0.25 per cent. However, at that time, and in statements since, Governor Macklem has indicated a rising path for the policy rate through 2022, which is widely expected to commence with a 0.25 per cent increase at its next meeting on March 2.
US retail sales surged with headline sales up 3.8 per cent month-on-month in January (versus 2.0 per cent expected). The US Fed’s Federal Open Market Committee (FOMC) minutes from the January 25-26 meeting appeared, not unexpectedly, to consolidate the notion of a Fed hike when it next meets on March 15-16. The minutes indicate some concern regarding inflation pressures which should only have intensified since with the release of inflation data running ahead of expectations (see above).The data has market pricing leaning toward a 50bp increase in March while the Fed’s policy rate is expected to be in excess of 1.50 per cent by year-end.
Coming up: Australian labour force
The Australian January labour force data to be released today is a little difficult to forecast with any confidence given the pervasive impact of the disruptions caused by the spike in omicron COVID infections in the month.
There is likely to be some (perhaps small) decline in employment but any upward movement in the unemployment rate could well be tempered by falling participation, so the unemployment rate might remain close to levels it last saw in the mid-1970s. It will need a big “miss” in employment for the unemployment rate to have any impact on the RBA’s communication, let alone decision-making.
Forward indicators of the labour market remain very strong, and it is expected the labour market will rebound sharply and continue to tighten over the coming months.
With RBA inflation and wage forecasts seemingly firmly at the downside end of the inflation risk continuum, if the unemployment rate persists at close to 50-year lows, the question becomes how long can the RBA persist with monetary settings only an modest step-back from those it had previously described as “emergency” settings.
Of course, the RBA may feel the need to wait for official inflation and wage data before moving. However, as outlined above, however, the problem is that such data are released with relatively unhelpful time-lags.
By Stephen Miller, GSFM investment strategist