Stephen Miller
Reserve Bank of Australia (RBA) raises 25 basis points as expected. Wages growth to challenge the “Australian exceptionalism” narrative. Upside risk to market pricing of the RBA policy rate.
As was largely anticipated the RBA increased the policy rate by 0.25 per cent to 3.10 per cent.
In announcing the decision, RBA governor Philip Lowe said that “inflation in Australia is too high” and further added that the RBA Board “expects to increase interest rates further over the period ahead” and further that the Board “remains resolute in its determination to return inflation to target and will do what is necessary to achieve that.”
However, the governor noted lags in the effects of monetary policy and added that the Board is “not on a pre-set course” when it comes to policy rate increases and 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.”
That is all reasonably defensible and, importantly, the form of communication from the governor gives the RBA some optionality going forward, something that was lacking from the governor’s communication through 2021 and into 2022.
However, there is no escaping the notion that the RBA is among the more dovish central banks, having kept the policy rate lower than a number of similar developed economy central banks.
The policy rate in Australia will finish the year at 3.10 per cent, below that of the US Federal Reserve (Fed) (likely 4.50 per cent), the Bank of Canada (4.25 per cent), the Reserve Bank of New Zealand (4.25 per cent) and even the Bank of England (likely 3.50 per cent). Only the European Central Bank (which only abandoned pandemic “emergency” settings in June will finish 2023 with a lower policy rate somewhere between 2.25 per cent and 2.5 per cent).
On that score, it appears that the RBA is consciously eking out a different path. The minutes from the November RBA meeting noted “that many major central banks had been raising policy rates quickly and were more likely to err on the side of doing too much rather than too little.”
Those comments indicate that the RBA was eschewing such a course.
Some of this reflects a belief in “Australian exceptionalism”: the notion that Australia’s wage and inflation circumstances are “different” or somehow less challenging than elsewhere in the developed country complex. The evidence for such “exceptionalism” is scant.
Yesterday’s national accounts release revealed a sharp acceleration in annual wage growth to 4.8 per cent. While there were a couple of special factors at work in the most recent quarter (minimum wage decision and an increase in employer super contributions), it is highly likely that annual wage growth will accelerate from that 4.8 per cent level.
Treasurer Jim Chalmers was correct in his comments yesterday that wage increases to date have had little impact on RBA decision-making. What he omitted to say was that wage growth will most likely assume an increasing importance in RBA decision-making in the future – and in a way that means the RBA may need to hike the policy rate beyond the current market-expected peak of 3.60 per cent.
The RBA has defended its comparative caution by warning against “scorching the earth” to get inflation down, implying a more aggressive approach involves outsized costs in terms of activity and employment.
But drawing on the ‘70s experience, and in an echo of recent comments from Fed chairman Powell, an alternative construct is that that the “scorched earth” more likely comes from central banks exhibiting some prevarication in assuming an aggressive role in containing inflation and then having to slam the brakes aggressively later on in the piece.
Of course, the RBA might be on the right track. Time will tell.
But domestic wage and price indicators on the whole continue to exhibit considerable momentum.
While RBA communication may be more nuanced and, on the surface, at least gives the RBA optionality when it comes to policy, I fear that it is overly reluctant to aggressively “walk the walk” on inflation.
That underscores the key risk with the RBA approach: that it admits the possibility of the emergence of the sort of inflation inertia that was last experienced on a global scale in the late ‘70s / early ‘80s.
As the RBA governor has noted the path to returning inflation to the 2 to 3 per cent target and keeping the economy on an even keel “is a narrow one.”
Even so, it will be closely monitoring wage developments and should be possessed of an acute inflation anxiety as it approaches 2023.
Interest rate markets should well heed that anxiety.
Bank of Canada raises the policy rate by 50 basis points to 4.25 per cent but signals possible near-term “pause”
In what was somewhat of a surprise to some the Bank of Canada lifted the policy rate by 50 basis points to 4.25 per cent but signalled the possibility of a near-term pause in the rate hiking cycle may be imminent.
The move represented a total of 400 basis points worth of tightening this year making the Bank of Canada among the more aggressive of developed country central banks.
The move come after the release of October inflation numbers that showed some signs of stabilising before a turning point, possibly reflecting the Bank’s relatively early display of monetary policy “athleticism”.
That earlier “athleticism” has seen the Bank of Canada arrive at a position to credibly contemplate a “pause”.
“Governing Council will be considering whether the policy rate needs to rise further to bring supply and demand back into balance and return inflation to target,” the bank said in a statement.
Even so, while clearly contemplating a “pause”, the Bank of Canada was careful to reiterate that it had not diminished its focus on inflation with Bank of Canada officials noting that “inflation is still too high and short-term inflation expectations remain elevated.”
That language suggests large increases to borrowing costs have probably ended, and that policymakers are open to a break in their forceful tightening campaign – or at the very minimum a step-down in the policy rate increment – as they weigh new economic data. There will be two more monthly inflation readings before the bank’s next rate decision on 25 January.
The Bank of Canada has clearly been persuaded of the efficacy of getting to “neutral” and beyond to “restrictive” quickly with last night’s move coming on top of sequential policy rate hikes of 100b basis points, 75 basis points and 50 basis points in July, September and October. That earlier policy “athleticism” has given the Bank of Canada the capacity to either reduce the policy rate increment or maybe “pause” the process altogether.
FOMC meets next week; A Fed “shade” not a “pivot”; Upside risk to bond yields in the short-term?
After an aggressive Federal Reserve (Fed) communication and action plan, markets looked to have received the message that the Fed’s primary goal is inflation containment and that it will take a policy rate of something more than 5 per cent to achieve the requisite containment.
However, more recently the bond market appears to have dialled down that judgement, perhaps reflecting growing recession fears. Those fears might be well-placed but the fact that inflation looms as the bigger economic menace to the Fed might mean again that the market is under-estimating the Fed’s determination to “stay the course”.
Recent Fed communication is consistent with the notion of a step-down in the policy rate increment to 50 basis points when it meets next week.
Equally, and as expressed in the minutes from the November meeting, the Fed now expects a higher cyclical peak.
The median September meeting “dot plot” suggested a terminal policy rate around 4.60 per cent. The new “dot plot” to be issued at the conclusion of next week’s Fed FOMC meeting will likely see an expected median policy rate peak higher than 5 per cent and, moreover, a median trajectory that is likely to stay elevated for a longer period than markets currently appear to contemplate.
Recession fears, along with better-than-expected October inflation reads, including important inflation ‘pulse’ measures such as the 3-month annualised core and Cleveland Fed and Dallas Fed trimmed-mean measures, may account for that market view.
Of course, as the saying goes, “one swallow doesn’t make a summer,” but the details in the release suggest that inflation has peaked and may have passed a turning point. The next FOMC meeting will have the benefit of assessing that as the meeting comes after the release of the November consumer price index (CPI) on 13 December.
However, the big question regarding future inflation is over the trajectory of services inflation. On that front the jury is still out. The 3-month annualised rate is running at 7.8 per cent up from 7.5 per cent in September but down from the peak of 9.9 per cent recorded in June. Continued elevated reads of the prices component from the Institute of Supply Management’s Services purchasing managers index (PMI) and an unexpected acceleration in wages growth in last week’s payrolls report argue for some caution regarding the pace at which inflation may decline and ease pressure on the Fed.
Probably reflecting some “stickiness” in services inflation, Federal Reserve officials have been mostly circumspect in their assessment of the degree to which the October figures would allow them to ease the foot off the brakes. That probably reflects a desire to consolidate the hard-won gains regarding market acceptance of its focus on inflation containment.
The Fed approach has come in for some reasonably pointed criticism from elements of the market commentariat and from both sides of politics. Through much of 2022, after the Fed’s embrace of an aggressive inflation containment approach, the critics charged that the Fed was unnecessarily consigning the US to an inevitable and unnecessary recession.
In my view those critics failed to learn the lessons from the ‘70s and the policy mistakes from the Fed under the leadership of Arthur Burns and G. William Miller, whose excessive caution wrought the (necessary) aggression of the Volcker era. The lesson here is 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 in terms of employment and activity down the track.
As chairman Powell stated during his press conference after the most recent FOMC meeting:
“…if we over tighten, then we have the ability with our tools, [then] we can support economic activity strongly if that happens, if that’s necessary. On the other hand, if you make the mistake in the other direction, and …it’s a year or two down the road and you’re realizing inflation behaving the way it can…you have to go back in. By then the risk really is that it has become entrenched in people’s thinking and the record is that the employment costs, the cost to the people that we don’t want to hurt, they go up with the passage of time…” (my emphasis)
Nevertheless, when all is said and done, there may be some light at the end of the tunnel for US financial assets. Even if the decline in bond yields may be a little over-done in the short-term, it is difficult to conceive of 10-years US Treasuries spending a great deal of time above the October peak around 4.25 per cent. For equities, the question remains whether earnings estimates have priced the likely cyclical downside. Even on that front the resilience of the US economy and labour market is encouraging. After unexpected residence in household spending and employment, the Atlanta Fed ‘GDPNow’ estimate for Q4 is currently running at a respectable 3.4 per cent.
In the short-term, however, the Fed may yet prove a catalyst for further bouts of volatility in markets before the year is out.
By Stephen Miller, Investment strategist