Stephen Miller
Much has been made of the RBA Board’s decision at its April meeting to leave the policy rate unchanged at 3.60 per cent.
That “pause” confirms the RBA’s status as among the developed world’s more dovish central banks and reflects a couple of key elements.
First, the RBA has an inflation view located very firmly at the more sanguine end of the risk continuum of plausible outcomes.
Second, the RBA believes it has the capability to “fine tune” any jobs / inflation trade-off by adopting a more cautious approach to inflation than other central banks.
Fair enough! We should wish them well.
Certainly, the decision to “pause” is not indefensible. However, there is an inherent riskiness with the RBA’s approach that suggests some gulf between wish and reality.
RBA forecasts of inflation have been way too optimistic for some two years and there is now a well-established pattern of the RBA’s inflation forecast needing to be re-cast upwards within a quarter of being released.
More importantly, regarding the inflation / jobs trade-off, a similar thinking lay behind central banks’ cautious approach to the fight against inflation in the late 1970s. What unfolded, however, was that inflation expectations became unanchored and an outsized dislocation in employment followed as central banks were forced to slam the monetary brakes harder, later in the piece.
In other words, history offers some inconvenient precedents when it comes to what the RBA wants to achieve and what might be possible.
In his Statement issued following the April RBA Board meeting, Governor Philip Lowe asserted that inflation expectations remain “well anchored”.
How that squares with the Australian Council of Trade Unions (ACTU) decision to pursue a 7 per cent wage increase for workers subject to minimum and award wage arrangements at the Fair Work Commission’s (FWC) annual review is difficult to fathom.
The ACTU claim – if entirely understandable – is a worrying portent of future inflation. Such claims, even if only partially granted, may simply spur inflation pressures as they ripple through the award system, and beyond, at a time when productivity has been going backwards. It is also unlikely to achieve the stated aim of lifting living standards of low-paid workers, as any gains are eaten up by higher living costs through inflation and – ultimately – higher interest rates and / or higher unemployment.
Some of the RBA’s caution reflects a belief in “Australian exceptionalism”: the notion that Australia’s wage and inflation circumstances are somehow less challenging than elsewhere in the developed country complex. The evidence for such “exceptionalism” is scant.
The Australian trimmed-mean measure of inflation is at the high-end for developed market economies and is likely to remain so after the release of the March quarter CPI on April 26th.
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.
Indeed, changes to the regulatory environment, particularly in relation to the wage-setting framework, run the risk of entrenching higher inflation in Australia compared to elsewhere.
There are also global structural currents that make elevated developed-country inflation rates more “sticky”. The 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) is abating, globalisation of goods markets is in retreat as governments everywhere introduce protectionist measures under the guise of “industrial policy” and “national champions”, while domestic regulation of markets is increasing in scope (leading to upward price pressures) and baby boomer workforce participation is declining (limiting labour supply and lifting wages).
The transition to clean energy involves ongoing costs to business, which is not to say it is undesirable, but it does complicate the task for inflation-focused central banks.
To be fair, Australia’s high immigration rate somewhat mitigates these influences, but it doesn’t eradicate them.
High frequency data such as the NAB monthly business survey continue to indicate considerable wage and price momentum. Even given the moderation in the NAB labour cost and price series evident in the March Survey, those measures remain elevated and well in excess of their historical levels vis-a-vis the trimmed-mean CPI. That suggests some upside to the RBA’s trimmed-mean inflation forecast.
The key risk with the RBA approach is 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 1970s / early 1980s and the much higher costs in terms of dislocations to growth and employment that follow as the central bank attempts to wrestle the inflation genie back in the bottle.
How that might line-up with the electoral cycle should concern the Government.
As the Governor has mentioned, the path between the vanquishing of inflation and avoiding a recession, or at least a sharp growth slowdown, is a narrow one.
If the RBA persists with its “pause”, the Governor’s path could get “tightrope narrow” – and the safety net looks ragged!
By Stephen Miller, investment strategist
