Stephen Miller
Reserve Bank of Australia (RBA) Governor Philip Lowe and his fellow Board members have had a torrid time of late.
In that context, last Wednesday’s March quarter consumer price index (CPI) release heralds a welcome respite from the barrage of critical appraisal that has attended the RBA’s monetary policy decisions and the recent review of its processes, performance, and structure.
The trimmed-mean (TM) March quarter consumer price index (CPI) was better than expected at 6.6 per cent. (versus 6.7 per cent expected) and indicates that the peak in inflation is behind us.
The March quarter CPI also indicates that TM inflation is declining at a slightly more rapid pace than envisaged by the RBA in its February Statement on Monetary policy (SoMP). That means the RBA can extend the current “pause” in the policy rate when it meets again in May, and perhaps beyond.
That is an outcome that will surprise some, including, it must be said, this writer.
The inflation report also represents a vindication of sorts for the more cautious approach from the RBA in raising the policy rate, compared with other developed country central banks.
RBA Governor Lowe has previously mentioned that the path between the vanquishing of inflation and avoiding a recession, or at least a sharp growth slowdown, is a narrow one. Based on the March quarter CPI figures the path got a little wider.
The Governor has acknowledged the RBA’s more cautious approach and cast it in terms of avoiding unnecessary job losses. In other words, the RBA believes it has the capability to “fine tune” any jobs / inflation trade-off. In embarking on that course, the RBA has indicated a high tolerance for an elongated return of inflation to the target zone of 2 to 3 per cent. The February SoMP indicates the RBA does not expect that to occur until the June quarter 2025.
While the March quarter inflation numbers represent some vindication of the RBA approach, there are grounds for some residual caution in heralding the end of the cyclical peak in the policy rate.
While lower than expected Australia’s TM inflation rate at 6.6 per cent is still higher than other developed countries such as the US (March TM at 6.2 per cent); Canada (March TM at 4.4 per cent); New Zealand (March quarter TM at 5.8 per cent); UK (March core at 6.2 per cent); and Eurozone (March core at 5.7 per cent).
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 wrestle the inflation genie back in the bottle.
RBA tolerance of a more elongated return to the 2 to 3 per cent inflation target increases the risk associated with exposure to even minor supply and/or other shocks that intensify inflation pressures.
In other words, and despite the optimism engendered by the March quarter CPI report, history offers some inconvenient precedents when it comes to what the RBA wants to achieve and what might be possible, even if the orders of magnitude involved are considerably less than experienced in the late ‘70s and early ‘80s.
There remains a number of elements that might upset the RBA vision of thow inflation might return to target.
The Fair Work Commission (FWC) has yet to conduct its annual wage review, including consideration of the Australian Council of Trade Unions’ (ACTU) submission calling for a 7 per cent wage increase for workers subject to minimum and award wage arrangements.
The ACTU claim – if entirely understandable – is a worrying portent of future inflation.
It may be that decision comes just as the inflationary push stemming from last year’s FWC mandated 5.2 per cent pay rise is abating.
Labour cost pressures largely account for ongoing and accelerating annual services inflation and the coming FWC decision may yet frustrate the RBA’s forecast return path to the 2 to 3 per cent target.
Changes in 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”; 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 over the longer-term but won’t eradicate them. Indeed, in the short-term, pressure on housing rents from immigration may tip inflation risks the other way.
Nevertheless, the March quarter CPI inflation measure will encourage the RBA in its approach and its tolerance of a more elongated path back to the 2 to 3 per cent target. In that context a continuance of the “pause” in policy rate hikes looks set to continue even if some negative risks remain. Barring an unanticipated spike in either the Monthly CPI indicator or wage measures, the next rate hike window will not occur until the 1 August Board meeting after the June quarter CPI release on 26 July.
By Stephen Miller, investment strategist