Stephen Miller
The Reserve Bank of Australia (RBA) minutes from the 4 July meeting contained similar themes to those that characterised Governor Lowe’s speech last week.
The minutes seek to give the RBA optionality on any future tightening measures.
In essence they indicate that the Board views current monetary conditions as restrictive but retain an open mind as to whether they are restrictive enough. (My own view is that monetary conditions are only marginally restrictive).
They do tend to pay a little more heed to weaker activity outlook than prior minutes. In regards to the weaker activity outlook, it might be that this week’s softer than anticipated China activity prints will not go unnoticed at Martin Place.
That said, I still find it hard to escape the conclusion that more policy rate rises will be needed for the central bank (and others) to establish any confidence that inflation is contained to same extent as in the US or Canada.
This Thursday’s labour force data is important and certainly relevant to any monetary policy calculus but barring any significant and unexpected weakening, the June quarter consumer price index (CPI) released on 26 July looms as more important.
The June labour force data to be released Thursday is expected to be consistent with ongoing tightness in the labour market, even if there is some retreat from elevated levels of labour market tightness in prior months. There may also be some ‘statistical correction’ in the wake of May’s blockbuster 75.9k increase in employment. However, it is doubtful that retreat will be of sufficient magnitude to allay concerns about wage and price inflation.
The NAB monthly business survey for June indicated that wage and price pressures continued at very elevated levels into the June quarter. That same survey indicated some easing in labour market conditions from early in the year but are suggestive of ongoing reasonably buoyant employment conditions.
The consensus expectations reported by Bloomberg are for an increase in employment of circa 17k and an unchanged unemployment rate of 3.6 per cent – not that far from the 50 year low of 3.4 per cent.
Such an outcome would be consistent with the latest RBA forecast of 3.6 per cent in June before rising to 4 per cent by year-end and peaking at 4.5 per cent in June 2025.
That of course reflects forecast tepid gross domestic product (GDP) growth of 1.2 per cent in 2023 and 1.7 per cent in 2024.
Even with forecast of tepid growth, the most recent quarterly Statement on Monetary Policy (SoMP) does not forecast inflation getting back to the top of the current 2 to 3 per cent target range until mid-2025. That reflects an unusually high tolerance of inflation compared to other developed country central banks.
My view is that further increases in the policy rate are more likely than not, largely because I see upside risks to the RBA’s inflation forecasts.
The Fair Work Commission’s (FWC) recent wage decision will indubitably increase price pressures and just as indubitably increase pressure on the RBA for further policy rate increases. The wage increases awarded by the FWC are digestible in times of reasonable productivity growth, but the most recent national accounts showed productivity growth at an abject -4.5 per cent over the past year, and unit labour cost growth (the most relevant labour cost gauge for inflation) is at a whopping 7.9 per cent – and this was before the FWC decision. The Statement following the 4 July decision noted that “at the aggregate level, wages growth is still consistent with the inflation target, provided that productivity growth picks up.” (My emphasis).
That is a big “if”!
Recent changes in the regulatory environment, particularly in relation to the wage-setting and the industrial relations framework run the risk of entrenching higher inflation in Australia compared to elsewhere, particularly as they weaken the link between productivity improvements and real and nominal wage growth.
This is at a time when the RBA has been a “laggard” when it comes to tightening and where Australia’s relative inflation performance has been slipping.
These are domestic developments that will be of some concern to the RBA as it wrestles with an already forecast elongated return of inflation to target.
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. The FWC decision and the “unintended consequences” of labour regulation may make that path an even narrower one.
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).
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.
The forgoing leads me to conjecture that the policy rate will need to reach at least the “high 4s”, implying at least another two 25 basis point (bp) policy rate increases between now and year-end to bring inflation back to the 2 to 3 per cent target zone within an acceptable timeframe, while at the same time minimising the dislocation in activity growth and employment.
Turning an eye to the 1 August meeting, the likelihood of an increase is critically dependent on what the June quarter CPI (released on 26 July) reveals, and further assessment of the inflation pressures spawned by the FWC decision.
A trimmed CPI mean outcome greater than the current RBA forecast of 1.1 per cent quarter on quarter or 6.0 per cent annual likely means a further increase. The recent NAB survey revealed accelerating labour costs and retail prices in June that imply upside risks to the RBA inflation forecasts for the June quarter and beyond as the inflation consequences of the FWC decision ripple through the economy.
US retail sales/Canadian CPI
US retail sales
On the whole, US retail sales were a little weaker than expected but not significantly so.
They are unlikely to move the dial for the Federal Reserve (Fed) when it meets next week.
Last week’s June CPI was more important. The CPI numbers indicate that progress in getting inflation down may be tracking at a faster pace, albeit ever so slightly, than what is embodied in the most recent Fed forecasts.
They strongly suggest that the Fed is within sight of the end of the tightening cycle.
However, it is likely the CPI outcome won’t be enough for the Fed to eschew one more 25 basis point increase when it meets next on 25-26 July (although that is not certain).
However, such an increase will be framed as ensuring the vanquishing of inflation and the subsequent 5.25 to 5.5 per cent target would almost certainly represent the peak policy rate for the current cycle.
The best guess now must be that the path for the Fed from hereon in the cycle is “one and done”.
Canadian CPI
The Canadian June CPI inflation report was a bit of a mixed bag.
While the report indicates ongoing “stickiness” in inflation, there are some signs of grudging progress that suggest that the aggressive approach exhibited by the Bank of Canada through 2022 toward containing inflation should eventually pay a dividend.
The June headline number fell to a better-than-expected 2.8 per cent from 3.4 per cent in May (largely reflecting base effects associated with the fall in energy prices) while the core measure also came in better-than-expected at 3.2 per cent from 3.7 per cent in May. The key median and trimmed mean measures, however, were a little higher than expected at 3.9 per cent and 3.7 per cent respectively, even if both of those measures showed marginal retreat from May.
Just last week, in the wake of an apparent deterioration in the inflation outlook, the Bank of Canada (BoC) increased the policy rate a further 25bps at its meeting overnight to take the policy rate to 5 per cent. This followed an increase of 25bps at its previous meeting in early June. The BoC had left rates unchanged at meetings in April and March.
In the accompanying monetary policy report, officials forecast inflation will stay around 3 per cent for the next year before gradually declining to the 2 per cent target in mid-2025. This was two quarters later than previous projections and probably accounts for the decision to increase the policy rate at last week’s meeting.
Beside a commitment to remaining “resolute” in its commitment to returning inflation to the 2 per cent target, the Bank provided little guidance on its future plans.
In one sense, given some lingering anxiety over inflation and its apparent “stickiness”, that is not surprising. However, what might surprise some Australian observers is how much lower Canadian trimmed-mean inflation is at 3.7 per cent (compared with 6.6 per cent to March quarter in Australia and an RBA forecast of 6.0 per cent in the June quarter) and how high the policy rate went to get it there (5.0 per cent in Canada versus the current 4.1 per cent in Australia).
At face value that might suggest that the RBA has a bit more ‘wood to chop’ on policy tightening.
Coming up: UK June CPI
Recent monthly releases of the UK CPI have been indicative of the serious challenges confronting the Bank of England.
There is every prospect those challenges will remain after the release of the June CPI figures this evening.
Base effects are expected to see the headline rate fall to 8.4 per cent from 8.7 per cent in May.
Core inflation, however, is expected to be unchanged from May at 7.1 per cent, among the highest in the developed world.
A June CPI outcome closer to consensus would almost certainly see a further increase of at least 25 bps at the 3 August Bank of England (BoE) Monetary Policy Committee (MPC) meeting. It is not inconceivable that an outcome close to consensus would see an increase of 50bps at that time.
A higher than expected print may see markets price the terminal rate higher from the current level just over 6 per cent to something closer to 6.5 per cent (which is close to where it was just a couple of weeks ago). That compares with the current 5 per cent rate.
Indeed, given higher than anticipated wage growth numbers for May released last week (7.3 per cent ex-bonus; 6.9 per cent including bonus), a further upside surprise might well be on the cards.
The BoE is not solely responsible for the awkward circumstance in which the UK economy finds itself. The mismanagement of Brexit occasioned by a distracted Johnson Government and the turmoil wrought by the fleeting Truss Government indisputably played major roles, including adding unnecessary inflation pressure.
But at various times through 2022, the BoE created an impression that it was reluctant to embrace a frontline role in containing inflation. Nor did it seek to avail itself of opportunities to ‘lean in’ to inflation pressures generated by poorly designed Government policies. In that sense it is complicit in the creation of the challenging circumstances created by the stubborn UK inflation, even if more recently it has hardened up its anti-inflation rhetoric.
The UK inflation circumstance stands in contrast to the progress in the US and Canada where after a stumbling start those central banks embraced an aggressive and unambiguous focus on inflation. There is evidence that approach of the Fed and Bank of Canada is close to achieving its aims.
The lesson from the ‘70s is that any delay on the part of a central bank 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.
Hopefully the RBA (and Government) have noted the costs associated with the BoE approach.
As far as the Australian 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”). If prior RBA prevarication, combined with a potentially challenging inflation environment requires the RBA to slam the brakes later in the cycle resulting in an even greater dislocation in activity and employment then that might create political (and not just economic) challenges for the Government.
As for the UK, the risk now is that scale of rate hikes the BoE must now visit on the UK economy to contain inflation mean that the extent of any future dislocation in activity growth and employment will be greater than need have been.
In the Australian context a better political strategy may have been (still is) “a little more a little sooner”.
And the Conservatives hopes of clinging to power grow even more remote.
By Stephen Miller, investment strategist.