Stephen Miller
US July CPI: enough for an indefinite abeyance but a policy rate “plateau” not a “peak”
The July consumer price index (CPI) report reaffirms the message from the previous two months that that inflation has meaningfully turned. Accordingly, the Federal Reserve (Fed) tightening cycle is likely in abeyance – maybe indefinitely.
Even with that abeyance, I expect the Fed to retain its “high indefinitely” mantra meaning that any policy rate cuts are not likely to occur until well into 2024.
While headline inflation rose to 3.2 per cent from 3.0 per cent in June, that reflected the vagaries of base effects largely associated with energy prices and was in any case slightly better than markets had anticipated. Core CPI fell to 4.7 per cent from 4.8 per cent from in June, its lowest since October 2021.
More significant is that measures of the ‘inflation pulse’ are indicative that peak inflation is well behind us, and meaningfully so.
The 3-month annualised core CPI was 3.1 per cent in July, down from 4.1 per cent in June and the lowest since September 2021. Even more encouraging was the fall in the 3-month annualised Cleveland Fed trimmed-mean measure to 2.7 per cent in June, the lowest level since March 2021. The Cleveland Fed median measure was less impressive at 3.8 per cent but that was the lowest since August 2021.
There might be some minor residual concern regarding the “stickiness” of services inflation. The 3-month annualised rate of services inflation rose slightly to 3.6 per cent from 3.4 per cent in June. While the annual rate of services ex-rent of shelter also rose marginally to 3.3 per cent from 3.2 per cent in June.
Importantly, however, the July CPI report overall indicates that progress in getting inflation down may be tracking at a slightly faster pace than embodied in the most recent Fed forecasts published in June, the “stickiness” in services notwithstanding. And while Fed officials are properly wary of declaring “mission accomplished”, the clear progress on inflation must surely cast doubt in the minds of Fed decisionmakers regarding the advisability of a further policy rate hike at the meeting on 19-20 September. Nevertheless, given the “stickiness” on the services side, I can see the utility in continuing to telegraph a “high indefinitely” message. In other words, the policy rate is at best at a “plateau” rather than a “peak”.
Despite a stubborn refusal of the data to comply, the market commentariat has been forecasting a recession for almost 2 years.
And while recession remains a non-trivial (even if substantially reduced) risk, it is less likely that Fed tightening is the proximate cause. Indeed, barring a financial ‘accident’ (China, internecine trade wars and protectionism, confused regulatory structures, escalating debt concerns) markets seem to be moving to substantially diminish any emphasis on a recession narrative.
That is not surprising. With inflation containment within reach, the notion that the Fed could successfully “thread the needle” and engineer a relatively benign disinflation (so-called “immaculate disinflation”) without an excessive dislocation in activity and employment – a ‘Goldilocks’ scenario – looks to be within grasp.
Finally, if indeed the Fed has done as good a job in managing disinflation as it appears to have done, then that will give it the wherewithal to respond to financial accidents. Not all central banks – including the Reserve Bank of Australia (RBA) – find themselves in as comfortable a position.
NAB Monthly Business Survey: The Fair Work Commission pokes the inflation bear!
I have a suspicion that Tuesday’s release of the NAB Monthly Business Survey may have occasioned some amount of hand-wringing at the top end of Martin Place.
I am a little surprised at an apparent lack of hand-wringing in the markets.
That survey revealed resilience in conditions and confidence and some slight strengthening in leading indicators.
That is the good news!
The hand-wringing should have eventuated from a reacceleration in labour cost growth and prices. Moreover, such an acceleration is occurring at a time of already elevated inflation, the slightly better June quarter consumer price index (CPI) report notwithstanding.
In some sense, that reacceleration should not surprise: the Fair Work Commission (FWC) wage review decision announced in early June took effect on 1 July and the NAB labour cost (and price) measures reflect that.
That should be obvious, but I am not convinced that the RBA forecasts released with the August Statement on Monetary Policy (SoMP) adequately reflect the upside risks to inflation generated by the FWC decision.
That decision is likely to see inflation in Australia exhibit a greater degree of “stickiness” than in other developed countries. This is not something that in my judgement is well understood by the market commentariat.
Sure, there are risks that go the other way, such as indications of weaker activity growth and ongoing weakness in China but those risks are understood by the market commentariat and well reflected in their inflation outlook and in the RBA forecasts.
There is also the notion that despite inflation risks, rising recession risks should lead to an indefinite delay in any further policy rate hike(s).
That would be a mistake.
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 activity and employment down the track.
The NAB Business Survey suggests that a clear and present danger is in the reacceleration of labour costs and prices.
The RBA has been a ‘laggard’ when it comes to tightening and where Australia’s relative inflation performance has been slipping. That is a consequence of the RBA showing a much greater tolerance in terms of the expected timeframe attaching to the return of inflation to target than some other central banks. It could mean that the impact on employment and activity growth may well end up being greater than would otherwise have been necessary had the RBA shown some greater application to inflation containment earlier in the piece.
By contrast, US and Canadian trimmed-mean inflation is running at annual rates of 4.8 per cent and 3.7 per cent respectively (compared with 5.9 per cent in Australia) and the policy rate is much higher in those two countries (a target of 5.25- 5.5 per cent in the US; a target of 5 per cent in Canada; versus the current 4.1 per cent in Australia). Moreover, the consequences for activity and employment in the US and Canada have been so far at least largely contained.
Despite a slightly better outcome for the June quarter CPI, the return of Australian inflation to somewhere within the target 2-3 per cent band is now even more elongated than forecast back in May, with that now not scheduled until “late 2025” (rather than the June quarter 2025 as forecast back in May).
By contrast to the occasional prevarication exhibited by the RBA, when the Fed and Bank of Canada (BoC) turned their attention to containing inflation, they were resolute in their focus. There is evidence that the approach of the Fed and BoC is close to achieving its aims.
By failing to ‘lean in’ to general inflation pressures earlier, any failure to ‘lean in’ to the specific pressures generated by the FWC decision might mean that the scale of rate hikes the RBA need visit on the Australian economy to contain inflation will mean any future dislocation in activity growth and employment will be greater. This is not dissimilar to the circumstance confronting other central banks, such as the Bank of England and the European Central Bank, who exhibited a similar prevarication in the containing inflation, even if both those central banks recently have latterly hardened their anti-inflation stance.
Of course, as the RBA Governor has noted, “at the aggregate level, wages growth is still consistent with the inflation target, provided that productivity growth picks up.” (My emphasis).
Needless to say that is a big “if”, given Australia’s poor productivity performance and a not unconnected disposition on the part of the political class to avoid confronting productivity challenges for the last two decades.
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 should be of ongoing concern to the RBA as it wrestles with an already forecast elongated return of inflation to target.
In order to tame the inflation bear, the policy rate may well need to go higher – perhaps significantly so – in order to bring inflation back to the 2-3 per cent target zone within an acceptable timeframe while at minimising the dislocation in activity growth and employment.
By Stephen Miller, investment strategist