Stephen Miller
After having increased the policy rate at both the May and June meetings, the Reserve Bank of Australia (RBA) Board decided to leave the policy rate unchanged at 4.1 per cent in July.
That was a surprise to some. However, such a move is certainly not indefensible even for those who believe (like this writer) that there are further increases in the policy rate in the offing.
Indeed, the RBA was keen to avail itself of that option noting that “some further tightening of monetary policy may be required to ensure that inflation returns to target in a reasonable timeframe”.
Having said that, the tone of the Statement appeared more directed toward an enunciation of the downside risks to growth rather than the upside risks to inflation which were much more prominent in the May and June Statements. That may have reflected the fact that the Statement attached to a decision to leave the policy rate unchanged rather than attaching to increases, as was the case in May and June, and the Statement was a long way from a worrying sanguinity on the outlook for inflation.
A “skip” in July will allow the RBA “time to assess the state of the economy and the economic outlook and associated risks”. That is not unreasonable, particularly given the lags with which monetary policy operates and the greater frequency of RBA Board meetings compared with their developed country counterparts (monthly as opposed to every 6 weeks). (The RBA will go to 6-week cycle with the implementation of the recommendations from the recent RBA review – an RBA fit for the future.)
The Statement notes that the RBA Board “is still expecting the economy to grow as inflation returns to the 2 to 3 per cent target range, but the path to achieving this balance is a narrow one”. That growth is expected, however, to remain tepid and the unemployment rate is expected to rise.
Even with that 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. Indeed, the RBA review recommended a greater focus on the mid-point of the 2 to 3 per cent target range rather than simply being content with being in the range itself. At the margin that may encourage an even tighter ‘on average’ stance of monetary policy.
The May and June increases reflect in part an attempt to quarantine the consequences stemming from the recent Fair Work Commission (FWC) wage decision. That decision will indubitably increase price pressures and just as indubitably increase pressure on the RBA for further policy rate increases. Such wage increases 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.
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 be in the “high 4s”, implying probably 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 consumer price index (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.
Fed FOMC June meeting minutes, coming up: US June non-farm payrolls
Federal Reserve (Fed) FOMC Minutes
Not unexpectedly, the minutes from the Fed’s Federal Open Markets Committee (FOMC) meeting in June confirmed that the “pause” was a hawkish one, with the degree of unanimity regarding a “pause” perhaps not as strong as presented in the immediate wake of the meeting.
That isn’t entirely a surprise: Chair Powell has indicated that more policy rate hikes may be in the offing as he expressed ongoing anxiety at the pace at which inflation is falling. That sentiment has more or less been echoed by various Fed speakers since the conclusion of the June meeting and is (to a degree) reflected in market pricing.
Indeed, in the projections issued at the time of that meeting, the median “dot plot” of FOMC members projected a policy rate of 5.6 per cent by end-2023 compared with the current 5 to 5.25 per cent target and up from the 5.1 per cent projected in March.
However, the decision to “pause” was a concession to ongoing uncertainties with respect to economic conditions, and a nod to the lags with which monetary policy operates, particularly given the notable tightening in credit conditions evident in the most recent Fed Senior Loan Officer Survey.
There is a view that the Fed’s retention of its “hawkish” disposition may in some measure be a device to forestall a further easing in financial conditions.
The minutes indicate that while there might be something to that view, the overarching consensus among Fed officials is that more rate hikes are on the way.
The veracity of those recent projections will hinge on upcoming data releases starting with Friday’s release of June non-farm payrolls and, perhaps more importantly, the June CPI figures released next Wednesday.
US June non-farm payrolls
The May US monthly non-farm payrolls report to be released on Friday will of course be keenly watched.
For much of the current tightening cycle, the bond markets have had a predilection for the Fed to commence an easing cycle much sooner than the Fed indicated or, indeed, now seems likely.
That predilection has been tempered substantially in the last couple of months, as the banking upheavals in March were apparently negotiated without (yet) igniting more broad-based systemic concerns and in the wake of “stickier” inflation, resilience in labour markets and ‘satisfactory enough’ activity indicators.
The May report was solid with a respectable 339k increase in employment, although the unemployment rate jumped to 3.7 per cent, from 3.4 per cent in April. Wages growth (as measured by average hourly earnings) was about as expected at 4.3 per cent, consistent with the ongoing “stickiness” in inflation evident in the various price-based inflation measures, but seemingly on a declining trend.
Markets will likely be particularly exercised on the extent to which the May report reveals any further tempering of wage pressure, as well as focusing on conventional measures of employment growth and the unemployment rate.
The consensus estimates June non-farm payrolls are in for an increase in employment of around 225k and a downtick in the unemployment rate to 3.6 per cent, which is still close to a 50-year low. Average hourly earnings are tipped to tick down to 4.2 per cent annual growth.
Before that, however, The May Job Openings and Labour Turnover Survey (JOLTS) will be released on Thursday with expectations of job vacancies (openings) of around 10 million. Anything below the 9.8 million mark may lead to reassessments of labour market resilience going into Friday’s release.
Also important will be the employment component of the Institute for Supply Management (ISM) purchasing managers index (PMI) for services, also released Thursday. That component slipped into contractionary territory in May and a further decline in June may also prompt some reassessment of labour market resilience, particularly given the slide of the employment component of the manufacturing PMI into contractionary territory in June.
The ADP payrolls report was also released overnight and while a reasonable enough indicator, its record in foreshadowing month-to-month movements in the Bureau of Labour Statistics measure is mixed.
US June CPI
Inflation remains the key focus.
I harbour some doubt as to whether the Fed will deliver on all of its projected rate increases.
The May CPI inflation data suggested meaningful (if somewhat grudging) progress on inflation.
While core CPI remained elevated at 5.3 per cent from 5.5 per cent in April, measures of the ‘inflation pulse’ point to a meaningful turning point in inflation. For example, the 3-month annualised Cleveland Fed trimmed-mean measure fell to 3.2 per cent in May, the lowest level since March 2021. On the services side, the 3-month annualised rate of services inflation fell to 3.4 per cent, the lowest since September 2021, while the annual rate of services ex-rent of shelter fell to 4.2 per cent, its lowest since December 2021.
It was the “stickiness” in services inflation that had hitherto kept the FOMC on its moderately a hawkish tack. Progress on that front may be grudging, but it is progress nevertheless.
If there is further progress in June with annual core inflation going below 5 per cent and some further progress on the ‘pulse’ and service sector measures, the 25-26 July meeting might yet yield a surprise “pause”.
And given what we learnt from the minutes it wouldn’t be a small surprise!
By Stephen Miller, investment strategist