Stephen Miller
As was widely expected the Reserve Bank of Australia (RBA) chose to leave the policy rate unchanged at 4.10 per cent at Tuesday’s meeting.
That was appropriate given the most recent available data had pointed to some diminution of inflation pressure.
The release of the July monthly consumer price index (CPI) indicator last week was just the latest instalment. It followed the June quarter wage price index which revealed modest wage growth and a softer labour market (employment / unemployment data) for July (albeit one that followed very strong reports in May and June).
Put simply, the ‘data dependence’ criterion made the case for any increase policy rate at Tuesday’s meeting too difficult for the RBA to prosecute.
Ongoing China weakness just adds to the case.
However, while it might be safe enough to suggest that the peak of inflation pressures may be behind us, what the RBA chooses to do with the policy rate going forward may depend on how quickly inflation continues to abate. On that front there are reasons to be concerned about ongoing “stickiness” in inflation.
For one thing the CPI indicator does not capture the full CPI basket, being heavily weighted to goods. July’s figure of 4.9 per cent reflected ongoing goods disinflation but little of still-high services inflation. Indeed, Governor Lowe in his final Board meeting Statement explicitly recognised this risk noting that “[s]ervices price inflation has been surprisingly persistent overseas and the same could occur in Australia.”
The risks of persistent “stickiness” in inflation are arguably higher in Australia than elsewhere.
For another thing, there appears to be an emergent tendency for more wage increases to occur at the start of a new financial year, not the least reflecting the recent Fair Work Commission (FWC) wage review decision that takes effect from 1 July but is yet to be reflected meaningfully in any official data.
That circumstance presages a potentially meaningful acceleration of wage pressures in the second half of the year and probably means the August and September monthly inflation numbers and the September quarter CPI release (released late October) reveal some unwelcome “stickiness”.
As the Governor also noted in his Statement, “[w]ages growth has picked up over the past year but is still consistent with the inflation target, provided that productivity growth picks up.” (My emphasis)
Wednesday’s release of second quarter gross domestic product (GDP) numbers emphasise that is a big “if”. That data revealed an ongoing abject productivity performance with productivity falling by 3.6 per cent over the year to the June quarter, meaning unit labour costs (the most relevant labour cost gauge for inflation) have risen by 7.3 per cent over the same period despite contained wage growth of 3.7 per cent. (By contrast, statistics released overnight in the US showed annual unit labour cost growth of just 2.5 per cent, comprising wage growth of 3.7 per cent and productivity growth of 1.2 per cent, leaving US workers on the verge of positive real wage growth as inflation declines.)
Australia’s abject productivity performance is not unconnected with a 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 potentially exacerbate that problem, running 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.
I have also mentioned in the past, that 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 explains the RBA Governor’s reiteration on Tuesday that “[s]ome further tightening of monetary policy may be required to ensure that inflation returns to target in a reasonable timeframe”.
While not a harbinger of recession, Wednesday’s June quarter GDP revealed only tepid growth, even if it was consistent with the most recent RBA forecasts.
There is also the notion that despite inflation risks, that tepid GDP growth (or in some eyes, rising recession risks) should lead to an indefinite delay in any further policy rate hike(s).
Unless inflation meaningfully abates (which is highly contestable) that would be a mistake.
As a self-described “aged” 1970s ruminator – a ‘condition’ with which I am familiar – Niall Ferguson wrote for Bloomberg some time ago that “I keep having to remind people that the dream of pain-free disinflation was a recurring delusion of the 1970s”.
That is the lesson from the ‘70s: 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.
It was perhaps with this in mind that the Governor’s Statement on Tuesday 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.”
The above notwithstanding, there does not seem to be any near-term catalyst that would lead the RBA Board under the new Governor to implement a policy rate increase at the October meeting.
At a minimum the RBA would like the benefit of a look at the September quarter CPI data to be released on 25 October to ascertain whether the aforementioned risks are manifest.
By Stephen Miller, investment strategist
