Stephen Miller

Wednesday’s better than expected monthly consumer price index (CPI) indicator has raised the prospect that the Reserve Bank of Australia (RBA) may “pause” increasing the policy rate when it meets next Tuesday. This comes after the minutes from the RBA’s March meeting suggest a pause in hiking the policy rate would be on the table for the April RBA Board meeting.

Certainly, the decline to 6.8 per cent in February from 7.4 per cent in January and 8.4 per cent in December is unambiguously good news.

However, I do not think it is sufficient for the RBA to hit the “pause” button.

For one thing the monthly indicator has only abbreviated coverage of the basket of goods measured by the quarterly CPI and in any case, inflation remains at elevated levels in an absolute sense and relative to elsewhere in the developed country complex.

Second, some of the decline appears to reflect seasonal factors. The seasonally adjusted series slowed less sharply to 7.1 per cent from 7.3 per cent.

Third, other important data prints at the very least suggest some caution in asserting that inflation has meaningfully peaked.

My view remains that the policy rate needs a “4 handle” for the RBA to adequately contain inflation.

The Governor has recently indicated that decisions on policy rate increases are “data dependent”.

In so doing, four key indicators were cited as critical to the determination of whether to increase the policy rate:

• The March NAB Monthly Business Survey
• February Labour force data
• February Retail trade data
• Monthly CPI indicator

The first two key pieces of data unambiguously move the policy rate calculus toward a further increase in April.

Measures of the Australian ‘inflation pulse’ from the NAB Survey indicate that inflation pressures remain extremely elevated into the March quarter 2023. The 3-month annualised measures of labour costs and retail prices are at 10.2 per cent and 9.5 per cent respectively and while they are down from their peaks, they remain at historically high levels compared with the trimmed-mean CPI. That implies some upside risk to the RBA’s current trimmed-mean CPI inflation forecast even if the monthly indicator suggests otherwise.

This comes after the December quarter national accounts revealed a steep fall in productivity: GDP per hour worked fell 3.5 per cent over the year to the December quarter 2022, meaning that unit labour costs (the most relevant labour cost gauge for inflation) increased by more than 7 per cent over the same period. That may indicate that inflation, rather than reaching a peak, might simply be at a plateau, or at the very least that the path back toward the RBA inflation target might be a lot more elongated than currently anticipated.

The February labour force report showed strong increases in employment; an unemployment rate which at 3.5 per cent is close to 50-year lows; and a sharp increase in hours worked.

February retail sales were modest (and likely negative in real terms) but weren’t inconsistent with ongoing resilience in consumer spending.

Finally, as canvassed, the monthly CPI indicator was better than expected, but in the context of other data prints and still elevated inflation, it is not sufficient in my view to move the dial to “pause”.

This week, the Australian Council of Trade Unions (ACTU) stated that it would pursue a 7 per cent wage increase for workers subject to minimum and award wage arrangements at the Fair Work Commission’s (FWC) annual wage review. That is a worrying portent of future inflation. An indication from the Government that it would support an increase in the minimum wage in line with inflation (or something close to it) in its submission to the FWC’s review is also a concern. While well-intentioned, such a move may simply spur inflation pressures as it ripples through the award system and beyond, at a time when productivity has been going backwards. It is also unlikely to achieve its stated aim of lifting living standards of low-paid workers, as any gains are eaten up by higher living costs (through inflation and higher interest rates) and / or higher unemployment.

It is also a development that should worry an inflation-focussed RBA.

Like the European Central Bank (ECB) and the Federal Reserve (Fed) (both of whom increased the policy rate in March), the RBA also needs to weigh up the implications of any upheaval in the global financial system. But unlike Europe and the United States (US), Australia is at the periphery of the ripples emanating from that upheaval.

Moreover, Australia has underperformed its peers, such as the US, Canada and even New Zealand, on inflation. That is at least in part because of a less aggressive approach to policy rate increases. That can be perceived as the RBA exhibits some prevarication in confronting the inflation challenge.

Even given the grudging progress on inflation in the US, it is some way down from the peak around the middle of last year.

Canada’s peak is even more apparent as evidenced by a better than anticipated February inflation read. Trimmed-mean inflation in Canada is running at 4.8 per cent. That compares with the most recent read for Australia of 6.9 per cent over the year to the December quarter and that will probably remain above 6.5 per cent when the March quarter number is released on 26 April.

The Bank of Canada (BoC) could credibly opt to “pause” further increments in the policy rate at its meeting. The BoC has delivered a total of 425 basis points (bps) worth of tightening in this cycle making it among the more aggressive of developed country central banks. The “pause” comes after the release of February inflation numbers that exhibited signs of a meaningful turning point in inflation, reflecting the BoC’s relatively early display of monetary policy aggression.

There is not yet any meaningful turning point yet evident in the Australian quarterly CPI data.

As far as the Government’s (understandable) anxiety regarding higher interest rates, it is probably the case that given the election cycle, it is best to get interest rate rises out of the way more quickly rather than draw them out (“death of a thousand increases”). A premature pause may require the RBA to slam the brakes later in the cycle resulting in an even greater dislocation in activity and employment. That is the lesson to be drawn from the experience of the late ‘70s and early ‘80s.

The Bank of Canada showed the (economic and political) virtues of the alternative approach of aggressively confronting the inflation challenge.

Given the forgoing, the “data dependence” criterion cited by the Governor argues for further policy rate hike(s).

As at close of yesterday, Australian money markets are pricing no prospect of an increase in the policy rate in April. Such an outcome is not implausible given the RBA Board’s prior prevarication in aggressively tackling inflation. However, current money market pricing in Australia is at an extreme end of the risk continuum.

Admittedly, the current upheavals in the banking sector make for fine judgments on future policy rate increases, but like the ECB, which is also arguably behind the inflation curve, and the Fed, the RBA should proceed with a further increase in the policy rate when it meets on 4 April.

To refrain from doing so runs the risk of a diminution of the RBA’s already tarnished inflation-fighting credentials.

In the past the Governor has mentioned that the path between the vanquishing of inflation and avoiding a recession, or at least a sharp growth slowdown, is a narrow one.

Were the RBA to avail itself of a pause in the rate hike cycle, when the data dependence criterion has not been met, the Governor’s path could get even narrower.

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