Toward a fitter future: Reserve Bank of Australia surprises with a 25 basis point policy rate hike
Stephen Miller
In what was a surprise decision, the Reserve Bank of Australia (RBA) Board meeting on Tuesday decided to increase the policy rate to 3.85 per cent.
Following on from last week’s release of inflation data that implied that the trimmed-mean (TM) consumer price index (CPI) declined at a slightly faster pace in the March quarter than the RBA had forecast, markets had thought that the RBA would extend its “pause” in increasing the policy rate.
Tuesday’s decision might have been a surprise but is in my view eminently defensible.
It may also reflect a subtle shift in emphasis to err toward targeting a more rapid decline in inflation. The RBA had indicated a high tolerance for an elongated return of inflation to the target zone of 2-3 per cent. On the basis of the February SoMP inflation was not forecast to return to 3 per cent until the June quarter 2025. Last week’s release of the RBA review (An RBA fit for the future) commissioned by Treasurer Chalmers, recommended a greater focus on the mid-point of the 2-3 per cent target range rather than simply being content with being in the range itself.
At the margin that may have encouraged the subtle shift in emphasis revealed by Tuesday’s decision and the Governor’s subsequent Statement.
Indeed in Tuesday’s Statement, the Governor noted that inflation in Australia remains high and while goods price inflation is slowing, services price inflation is still very high and broadly based. He added that overseas experience is indicative of upside risks.
While marginally lower than was perhaps anticipated, 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%); UK (March core at 6.2%); and Eurozone (March core at 5.7 per cent).
Australia’s policy rate was also at the low-end of those prevailing elsewhere: the US Federal Reserve’s upper limit will likely be at 5.25 per cent following Wednesday’s meeting; the Bank of Canada policy rate is at 4.5 per cent; the Reserve Bank of New Zealand rate is at 5.25 per cent; the Bank of England is at 4.25 per cent with another 25 bps widely expected next week; and the European Central Bank’s main refinancing rate is 3.50 per cent and likely to go to 3.75 per cent when the Governing Council meets Thursday.
Despite Tuesday’s surprise, the Governor’s Statement on Tuesday noted that “some further tightening may be required to ensure inflation returns to target”.
What may also have been playing on the RBA Board’s mind was that the period ahead contains a number of elements that might upset the pre-existing RBA vision of the how inflation might return to target.
The Fair Work Commission (FWC) has 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.
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. Whether that persists or is unwound will need to await the March quarter national accounts which are not released until 7th June. The governor’s Statement on Tuesday specifically mentioned high unit labour cost growth with “productivity growth remaining subdued”.
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.
Finally, the RBA does seem to have revealed some nuance regarding its prior expression of a belief in its ability to “fine tune” any jobs/inflation trade-off. It had been thought (including by this writer) that the RBA’s more cautious approach to hiking the policy rate compared to other developed country central banks was about avoiding unnecessary job losses. A similar thinking lay behind central banks’ cautious approach to the fight against inflation in the late 1970s. What unfolded, however, was that caution saw 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.
In his Statement on Tuesday the Governor noted that “if high inflation were to become entrenched in people’s expectations, it would be very costly to reduce later, involving even higher interest rates and a larger rise in unemployment”. That is an explicit nod to the difficulties in the short-term of “fine-tuning” a jobs / inflation trade-off: in the medium to longer-term it can make matters worse.
By Stephen Miller, investment strategist
