Stephen Miller
The March quarter consumer price index (CPI) presents the Reserve Bank of Australia (RBA) Board with a clear and present challenge when it meets next Tuesday.
To recap, the six-month annualised inflation rate as measured by the RBA’s favoured trimmed mean measure is 4.9 per cent.
That is the highest on record since this data was first assembled 20 years ago.
It was in anticipation of inflation at this level that in November 2007 the RBA Board under then Governor Glenn Stevens increased the policy rate in an election campaign.
When the RBA Board meets on Tuesday it must take similar action. The inflation forecasts contained in the RBA’s February Quarterly Statement on Monetary Policy (SoMP) have been blown out of the water. Much the same happened to the November forecasts with the release back in January of the December quarter CPI.
Bear in mind, that the March quarter results do not reflect the full extent of the price pressures unleashed by the Russia-Ukraine conflict.
Most of the economic commentariat have pencilled in June as the most likely point for a policy rate lift-off giving the RBA Board the benefit of viewing the March quarter Wage Price Index (WPI) released on 18 May. They cite Governor Philip Lowe’s April Statement where pointing to the Board’s assessment of “important additional evidence…on both inflation and the evolution of labour costs.”
No more evidence on inflation is needed!
On labour costs, there is evidence of rapid acceleration already. The most recent March quarter NAB business survey showed labour costs increased 2.7 per cent, which was well above the previous 2 per cent record reached more than 15 years before.
The most recent WPI data are almost 5 months old. To be relying on updates to that series, the RBA risks institutionalising inertia in its policymaking.
At a minimum, the RBA should raise the policy rate in May and follow up with a further increase in June should the WPI even vaguely confirm what is being indicated by say the NAB survey.
That could mean a 15bps increase in May followed by 25bps in June.
To not do so the RBA runs the risk of making the same mistakes as the US Federal Reserve (the Fed) and European Central Bank (ECB) in placing themselves out of the realm of “first best” solutions (see below discussion of forthcoming Euro CPI).
Both the Fed and ECB are now being forced to confront a “least bad” approach. In other words, choosing between meeting an inflation target by causing a recession, or allowing high and potentially destabilising inflation to persist well into 2023.
The RBA should avoid joining them, if it is not too late already.
US – Q1 GDP, March PCE; EUR – EUR April CPI, Euro Q1 GDP; Japan – BoJ meeting
There’s quite a bit of important data coming up over the next day or two.
US
In the US tonight sees the release of Q1 gross domestic product (GDP) while Friday sees the release of the Fed’s favoured inflation measure in the March core personal consumption expenditures (PCE) deflator. The former is likely to see a sharp headline deceleration with the Bloomberg consensus around 1.1 per cent down from the Q4 rate of 6.9 per cent.
That largely reflects an expected sharp swing in the contribution from inventories from a strong positive in Q4 2021 to a big negative in Q1 2022. Such a number would not likely cause the Fed to deviate from the hawkish tack that it has recently embarked upon. Nor would it likely cause markets to radically alter their pricing of Fed rate hikes.
Having raised the policy rate by 25bps to 0.50 per cent in March, markets are anticipating successive 50bps hikes and the next two meetings in May and June and some prospect of another 50bps in July. Current market pricing has the policy rate well north of 2.5 per cent by year-end, implying at least another 200bps of tightening from here.
According to the Bloomberg consensus, the March core PCE deflator is expected to decelerate from an annual 5.4 per cent in February to 5.3 per cent in March, which would be consistent with the lead provided by the March core CPI.
The Fed’s forecasting record on inflation has been nothing short of abysmal in the last couple of years and having revised its forecast for the core PCE deflator substantially in March up to 4.1 per cent for 2022 from the 2.7 per cent it had been forecasting back in December 2021, it would welcome an apparent peak in inflation.
The bigger question remains whether the annual rate of inflation will decelerate to somewhere close to the forecast. There are troubling indications that inflation may well exhibit unwelcome “stickiness.” For example, sophisticated measures of ‘underlying’ inflation (such as the Cleveland Fed median and trimmed-mean measures) show accelerating inflation. Such 3-month annualised measures of the ‘inflation pulse’ are above 6.5 per cent (above 7 per cent in the case of the trimmed-mean measure), so even a number close to the consensus would seem to indicate considerable inflation challenges ahead.
Euro area
The Euro area releases provisional April CPI on Friday. Markets will get a good guide to this number with the release of German and Spanish April CPI this evening.
Expectations for German CPI are for the annual rate to decline somewhat to 7.2 per cent from 7.3 per cent in March. However, for the Euro as a whole, the consensus anticipates a slight acceleration to 7.5 per cent from 7.4 per cent in March.
When viewed in the context of mounting headwinds to growth from the Russia-Ukraine conflict and China’s lockdown, an elevated inflation outcome such as that expected illustrates starkly the particularly acute bind in which the ECB finds itself. While Friday’s Q1 GDP is expected to show modest growth of around 0.3 per cent, it is those headwinds that loom as more of a challenge.
Through a demonstrated complacence regarding inflation through 2021, and a wilfulness to ignore its mission statement (“price stability is the best contribution that monetary policy can make to economic growth”), the ECB has placed itself outside of the realm of “first best” solutions.
Despite an occasional flirtation with a more inflation-fighting stance, President of the ECB, Christine Lagarde, has essentially presided over the maintenance of monetary settings near historically high (“emergency”) levels of stimulus, despite a clear and present inflation problem.
As recently as two weeks ago, the ECB maintained its bond purchase program and left open the option for its continuance in Q3. Having let inflationary expectations escape the realm of being within its ability to comfortably manage without a serious risk of a substantial growth dislocation, the ECB is being forced to confront the question of the “least bad” approach. In other words, choosing between meeting an inflation target by causing a recession, or allowing high and potentially destabilising inflation to persist well into 2023.
Japan
The Bank of Japan (BoJ) meets today. The BoJ, perhaps understandably, has been at variance with the recent retreat (albeit belated) from other developed country central banks from historically high levels of monetary accommodation.
As for this meeting, no change to the policy rate is expected with no sign yet of a durable lift in consumer prices. The focus will be on Governor Haruhiko Kuroda’s press conference and any comments on the commitment to continue to constrain the rise in bond yields and how that may be sustainably affected.
