Stephen Miller
Tuesday’s release of Reserve Bank of Australia (RBA) meeting minutes from the October meeting note that the decision between moving the policy rate by 25 basis points versus 50 basis points was “finely balanced”.
Arguments for 50 basis points centred on “the inflationary environment and risks to inflation expectations”, while arguments for 25 basis points “rested on the risks to global and domestic growth, and the potential for inflation to subside quickly”.
The notion that these judgements were “finely balanced” was reinforced by later comments from RBA Deputy Governor Michele Bullock, who left the door open for a return to higher (40 basis points or 50 basis points) policy rate increments by noting that “the size and timing of future interest rate increases will continue to be determined by the incoming data and the Board’s assessment of the outlook for inflation and the labour market”. For good measure – and presumably to signal that the Board remains vigilant and has not taken its eye off the (inflation) ball – the Deputy Governor added that “the Board expects to increase interest rates further over coming months”.
In that context, were next week’s September quarter Consumer Price Index (CPI) to reveal an upside surprise (greater than 1.6 per cent quarter on quarter (qoq) or 5.6 per cent year on year (yoy)) it could well be the case that the RBA reverts to a higher policy increment at the November RBA Board meeting on 1 November.
Admitting that possibility is not inconsistent with the notion that the October decision was defensible. For one thing the greater frequency of RBA Board meetings compared with their counterparts elsewhere may have afforded the opportunity of lesser 25 basis point increment in October. The RBA meets monthly, as opposed to every 6 weeks like most of its developed country counterparts. A 50: 50: 25 basis point sequencing of rate rises over three consecutive meetings would be virtually equivalent to a 50:75 sequencing over two consecutive meetings in other developed country central banks.
However, while acknowledging that the downshift may have been a fine judgement, and certainly defensible, the Board may have opened itself up to some “awkward optics”.
If the pressures behind the greater than expected increase in September quarter inflation revealed in Tuesday’s New Zealand CPI release are revealed to be present in Australia, then the case for a higher increment than 25 basis points is indubitably stronger.
There is the notion – that episodically comes up in RBA commentary – that Australia’s inflation circumstances are “different” or somehow less challenging than elsewhere in the developed country complex. There may be some grain of truth in that – but only the tiniest grain. The big drivers of inflation in the developed world are clearly present in Australia and it was an underappreciation of them that lay behind the serious missteps in RBA communication through 2021.
Against that background, the extraordinary momentum in high-frequency price and wage measures in Australia mean the RBA (and markets) face a nervous wait for the September quarter CPI figures next Wednesday.
NAB September Monthly Business Survey indicated some easing in cost and price pressure from the July peak (around the time oil prices peaked and the Fair Work Commission minimum wage increase took effect). Nevertheless, costs have been elevated across the quarter and the evidence seems to indicate that firms have continued to pass these pressures onto their customers.
Using price measures gleaned from the Monthly Survey, NAB economists construct a simple ‘nowcasting’ model of the trimmed-mean CPI. That model suggests trimmed-mean CPI could be as high as 2 per cent (qoq) in the September quarter. That would see core CPI running at over 6 per cent (yoy) for the September quarter, indicating significant upside risk to the RBA forecast of 6 per cent at year-end. (It should be noted that NAB is not, however, forecasting trimmed-mean inflation as high as 2 per cent qoq opting for 1.6 per cent.)
The momentum in the high frequency data indicates a danger of the emergence of the sort of inflation inertia that was last experienced on a global scale in the late ‘70s / early ‘80s. (It lasted a little longer in Australia.) It underscores the notion that just as recession is a risk, so is a premature declaration of victory over the inflation threat.
In this context, the RBA Board might be grateful were “awkward optics” to be the extent of its challenges over the coming period.
Australian labour force numbers released today
The Australian September labour force data to be released today are expected to reinforce the notion of likely ongoing tightness in labour market conditions. The August release revealed the unemployment rate close to a 50 year low at 3.5 per cent, with employment increasing by 33.5k. The consensus expectations reported by Bloomberg are for an increase in employment of circa 25k and an unchanged unemployment rate at 3.5 per cent.
Regardless, it is difficult to argue against the proposition that labour markets are tight.
Anecdotes of this abound and the September NAB Monthly Business Survey showed a buoyant labour market.
As discussed above the critical release is the September quarter CPI next week but a labour force outcome close to consensus will not detract from a debate about a higher policy increment should the September quarter CPI show some surprise on the upside.
UK inflation is not for turning, UK records a double digit 40 year-high in inflation
In what has become a familiar circumstance the UK recorded another 40-year high double-digit inflation print in September. September headline CPI came in at 10.1 per cent up from the 9.9 per cent recorded for August. The core measure came in at 6.5 per cent up from 6.3 per cent in August.
While the narrative around high developed country inflation is well known (large increases in selected commodity prices and supply chain bottlenecks), it was a policy failure on the part of the Bank of England that, subsequent to the initial price shock ,served to compound the problem.
Brexit – or perhaps more pointedly a mismanagement of that process – also contributed, largely reflecting an unwillingness on the part of the government to address some of the supply chain issues and labour shortage issues that arose as a consequence.
The Bank of England’s complicity is a result of its inability to articulate and execute a coherent strategy for dealing with the inflation.
In saying that, I am acutely aware that the UK’s current economic woes are not solely down to the Bank of England. Boris Johnson’s government – either through distraction, sloth or an inability to progress from the mouthing of platitudes – contributed little, while the incoming Truss government’s problems have been canvassed in exhausting detail elsewhere.
But back to the Bank of England (BoE), the essential primary task of a developed country central bank is to contain inflation. The BoE’s failure in this is more egregious than nearly all of its developed country counterparts. (The possible exception is the European Central Bank – Germany has the highest inflation rate among G7 countries, something that not long ago would have been considered inconceivable by market-watchers and economic historians.)
Like nearly every other developed country central bank, the BoE was tardy in recognising just how great a challenge inflation would prove for monetary policy. However, in my view not only was it lax in recognising the problem, it has been lax (compared to other central banks) in attempting to rectify the consequences of its earlier policy missteps.
Many central banks (The Federal Bank, The Bank of Canada, the Reserve Bank of New Zealand, and maybe the Reserve Bank of Australia) appear to have learned (admittedly late in the piece) the lessons from ‘70s style inflation: viz, that any delay in articulating a coherent and firm response to an inflation threat only heightens the risks down of a more damaging macroeconomic dislocation down the track. It is not an easy task charting a course between vanquishing inflation without tipping the economy into recession. History is not replete with central banks executing that task successfully. However, the aforementioned at least give themselves a shot at “second-best” outcomes.
The BoE’s response was to partly default to a more highly risky approach of letting a squeeze on real incomes become the “cure” for a diminishing of inflation. That involves a more elongated and painful approach than an expeditious shifting of policy rates to neutral levels and beyond. In so doing it (along with the European Central Bank) appears to have unwittingly opted for a “nth” best strategy. That approach risks the worst of both worlds – a vicious and lasting stagflationary environment.
Moreover, Governor Bailey frequently gave the impression that he was unconvinced that the BoE had a frontline role to play in containing inflation. He has stated that it was a “well established practice to accommodate supply shocks where they’re expected to be transient”. He has said that he felt “helpless” in the face of global price pressures; and that he has “run out of horsemen” after the pandemic and the war in Ukraine.
These comments are at the very best contestable, and at the very worst are egregiously naïve for a senior central banker.
The assertion that price pressures were exclusively “supply driven” downplays the impact that the BoE’s extremely accommodative monetary stance had on inflation. Former BoE Governor Mervyn King (among others) noted that the BoE (and nearly every other developed central bank) had kept monetary policy too loose for too long.
The commodity /supply-chain narrative downplays the reversal of structural currents that account for the deflationary tendency of the past three decades: viz; globalisation of labour supply (after the fall of the Berlin Wall and the ‘export’ of labour from large emerging market economies such as China and India), baby boomer workforce participation. Other factors such as de-globalisation through protectionist measures and re-regulation are also relevant.
It is also not “well established practice to accommodate supply shocks”, even if they are expected to be transient and especially when monetary policy is at unprecedentedly accommodating levels. The notion of transitory inflation is that it doesn’t change wage and price setting behaviour. But there has been evidence for considerable time that these behaviours are changing. Even if it cannot influence supply levers in the economy, by failing to incorporate supply shocks in its monetary policy framework, central banks can magnify and perpetuate the inflationary damage such shocks can inflict. This is a key lesson from the 1970s.
More recently the BoE has looked to focus more particularly on inflation (when it is not distracted by managing the fallout from the Truss government’s disastrous fiscal efforts) but it might prove too little too late.
The “jumbo” rate hikes it must now visit on the UK economy mean that the feared “more substantial macroeconomic dislocation” canvassed above is already “baked in the cake”.
Gilts rally perhaps reflecting that, for the time being at least, markets have priced the notion that the BoE and Government will find it difficult to negotiate anything other than a highly disruptive path through the economic morass with the economy slipping into potentially deep recession. Longer-dated gilts may have derived some continued comfort from the BoE announcement that “quantitative tightening” will initially be focussed on shorter-dated bonds as well as the ongoing reversal of the measures contained in the Government’s “mini-budget”.
Sterling was weaker against the USD, in line with other currencies.
My own suspicion is that further bouts of volatility in UK assets may persist, and that the Gilt rollercoaster ride may continue as markets wrestle with the ability of the BoE to contain inflation despite the Government’s fiscal reversals.
Canada inflation also a little higher than expected despite early policy athleticism
Canada also recorded a slightly higher inflation rate than had been anticipated, although Canada’s inflation rate looked almost benign compared with the UK.
The September headline number fell to 6.9 per cent from 7 per cent in August while the core measures came in at 6 per cent down from 5.8 per cent. The key median and trimmed mean measures were at 4.7 per cent and 5.2 per cent respectively.
Nevertheless, Canada’s inflation rate shows some tentative signs of a plateau leading to a turning-point. That possibly reflects the Bank’s relatively early display of monetary policy ‘athleticism’. That was exemplified by a decision earlier in the year to abandon unambiguously the “transitory” inflation narrative and articulate a clear and credible strategy of dealing with the inflation challenge.
Along with the Reserve Bank of New Zealand (who admittedly – perhaps for structural reasons – have had less success), the Bank of Canada were persuaded of the efficacy of getting to “neutral” quickly and engaged in sequential policy rate hikes of 50 basis points, 100 basis points and 75 basis points in June, July and September.
Canadian bond yields jumped sharply perhaps reflecting in part higher US yields. More importantly, Bank of Canada Governor Macklem asserted earlier this month that there was “more to be done” on the policy rate.
So, while further increases in the policy rate are inevitable, the September inflation result may afford the opportunity of the Bank of Canada of dialling back the size of the policy rate increment to 50 basis points when it meets next Wednesday.
By Stephen Miller, investment strategist