Stephen Miller
In refreshing contrast to her predecessors and peers, new Reserve Bank of Australia (RBA) Governor, Michele Bullock, has an endearingly plain-spoken and direct approach.
That was on display this week.
In the first instance there was a very strong signal from the minutes of the October RBA Board meeting that should the September quarter consumer price index (CPI) to be released next Wednesday show inflation to be tracking above the RBA August Statement on Monetary Policy (SoMP) forecast, then the RBA Board will choose to raise the policy rate at its November 7th Board meeting.
Those minutes revealed that the Board “has a low tolerance for a slower return of inflation to target than currently expected,” which given asymmetric upside risks to the current RBA forecast is suggestive of a strong potential for a November policy rate increase.
In case markets missed the message, Governor Bullock reinforced that message in her comments to the Australian Financial Security Authority (AFSA) Summit on Wednesday when she noted that there were “a few things that are suggestive that it’s going to be difficult to get inflation down,” and expressed some anxiety regarding “pretty sticky” services inflation.
Those comments are entirely appropriate for a central bank that still faces some challenges when it comes to inflation containment.
As Governor Bullock notes, the “stickiness” attaching to services inflation (which in the main reflects wage growth) is not unique to Australia.
However, and while the Governor refrained from making this point, it is arguable that recent changes in the regulatory environment in Australia, particularly in relation to the wage-setting and the industrial relations framework, potentially exacerbate that problem because in large measure they weaken the link between productivity improvements and real and nominal wage growth.
The September quarter CPI (and perhaps the December quarter too) may reflect some consequence of the Fair Work Commission (FWC) wage review decision announced in early June, which likely intensified inflation pressures. Such wage increases are digestible in times of robust productivity growth. However, productivity growth in Australia is abjectly poor and even with relatively modest wage growth, unit labour cost growth (the most relevant labour cost gauge for inflation) is at over 7 per cent per annum.
As the Governor noted in her Statement following the RBA October Board meeting, “wages growth … is still consistent with the inflation target, provided that productivity growth picks up”. (My emphasis). That increasingly looks like a big “if”.
She also noted that the “recent data are consistent with inflation returning to the 2–3 per cent target range over the forecast period.” (My emphasis)
However, judging from her interventions this week, the Governor may now feel that the backward focus on recent data does nothing to assuage nascent anxieties that inflation in Australia will be revealed as “sticky” enough to force the RBA’s hand in November.
The recent September NAB Monthly Business Survey revealed some acceleration in wages and prices in the quarter, although to be fair that acceleration appeared to wane as the quarter progressed. The latter observation notwithstanding, the survey remains consistent with ongoing elevated (“sticky”) inflation.
Were those trends to presage a similar reacceleration of wage and price pressures in the more lagged official Australian Bureau of Statistics (ABS), particularly next week’s September quarter CPI released on October 25th, then a policy rate increase will be on the agenda for the next meeting on November 7th.
NAB economists issued a forecast quarter-on-quarter increase for the September quarter trimmed-mean CPI of 1.1 per cent (circa 5 per cent plus annual), above the RBA’s 0.9 per cent. In my view, on the basis of the price and wage numbers in the NAB Monthly Business Survey, there may even be upside risk to the NAB economists’ forecast.
In that context, RBA forecasts released with the August Statement on Monetary Policy (SoMP) may not adequately reflect the upside risks to inflation.
An annual September quarter trimmed mean inflation outcome of 5 per cent or above will inexorably put pressure on the RBA Board for a November policy rate hike.
Governor Bullock’s interventions this week suggests that the RBA is exercising its hawk’s talons.
The Fed: the talons remain extended!
Last week’s elevated core inflation result for September suggested that a further increase in the policy rate remains on the agenda for future meetings of the Federal Reserve Federal Open Market Committee (FOMC).
In my view, this week’s September retail sales release all but confirmed that.
Moreover, I expect that to be the key takeaway when Fed Chair Powell addresses the Economic Club of New York at midday Thursday (3am Friday morning AEDT).
While it is conceivable that the march higher in bond yields may see the Fed keep policy rate hikes in abeyance, Chair Powell will seek to give markets the message that further hikes remain an option and reinforce the “high indefinitely” mantra that it has attached to its recent commentary on the policy rate. That would imply that current Fed thinking does not contemplate any policy rate cuts until at least the second half of 2024.
So for the time being at least the policy rate is at best at a “plateau” rather than a “peak”.
Chair Powell’s comments are likely a device to forestall a further easing in financial conditions. The US bond market has consistently under-estimated how high the Fed would take the policy rate and how far the Fed is from contemplating any cut in the policy rate. Markets have more recently tempered their difference of view with the Fed, and given ongoing resilience in activity data, Chair Powell will be careful not to excite any exuberance. Certainly, to the extent that bond yields remain at levels not seen since 2007 means that the Fed has been successful in this endeavour.
Chair Powell would not wish those hard-won endeavours to be compromised.
The talons remain extended
BoE and UK CPI: lost talons (or perhaps a “dove’s breakfast”)!
In the wake of some evidence of moderating (albeit still highly elevated) inflation numbers in August, the Bank of England (BoE) Monetary Policy Committee decided by a narrow 5-4 margin to eschew an increase in the policy rate at its September 21st meeting, maintaining the base rate at 5.25 per cent.
That decision surprised some (including this writer) who had thought the BoE might have learnt some lessons from the appearance of prevaricating in the face of the inflation challenge it was facing in 2022.
The September consumer price index released overnight go to emphasise that the BoE still has a fight on its hands and that any extended prevarication on its part in assuming a frontline role in the fight against inflation risks a more substantial macroeconomic dislocation down the track. As the self-described “aged” 1970s ruminator, Niall Ferguson, wrote for Bloomberg some weeks ago he “keeps having to remind people that the dream of pain-free disinflation was a recurring delusion of the 1970s”. In other words, the lesson from the 1970s is that any delay on the part of a central bank in enacting 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 BoE is running that risk.
The September release showed headline inflation unchanged at 6.7 per cent in September (versus 6.6 per cent expected).
On a core basis annual inflation was slightly higher than expected at 6.1 per cent versus 6.0 per cent expected and 6.2 per cent in August.
These numbers followed elevated wage growth numbers released on Tuesday night (8.1 per cent including bonus; 7.8 per cent ex-bonus). Such numbers should only intensify concerns about ongoing “stickiness” in inflation.
The next BoE meeting is not scheduled until 2nd November. Markets were pricing only a 30 per cent chance of an increase in the policy rate to 5.5 per cent. That may reflect an assessment that the BoE has “lost its talons” and despite the eminently prosecutable case for a further policy rate hike, the BoE will decline to do so. I would have thought given the surprising nature of the September decision and the closeness of the vote in September that the chances should be much higher than 30 per cent.
At a minimum a further hike is justified on “insurance” (against inflation) grounds.
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.
In addition, the BoE’s job is arguably more difficult than in most other developed countries, at least with respect to the inherent inflation proclivities peculiar to the UK. These reflect a number of factors:
- Stronger resistance to further real wage erosion among segments of the labour force, evidenced by the combination of the highest nominal wage growth and widespread industrial action.
- Disruptions in external trading relations post-Brexit that slow supply chains and make them less cost-effective.
- A lower degree of internal economic flexibility contributing to longstanding productivity challenges.
- Limited government support for supply-side enhancement in comparison with the efforts of the US and, to a lesser extent, the Eurozone.
In that context it is no surprise that the UK has among the highest inflation readings in the developed world, and certainly the highest in the G7.
But that should have escalated the urgency of the BoE in embracing a frontline role in containing inflation.
Yet, the BoE has not sought to avail itself of opportunities to more ostensibly ‘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.
That is the nature of costs associated with the BoE prevarication.
The risk now is that scale of rate hikes the BoE must visit on the UK economy to contain inflation will only grow the longer it prevaricates and that, accordingly, the extent of any future dislocation in activity growth and employment will be much greater than it need have been.
The BoE needs to find its talons or the UK economy will end up looking like a “dove’s breakfast”!
