“Sticky” services inflation suggests a policy rate hike remains on the Fed agenda and NAB Monthly Business Survey leaves open the prospect of further rate hikes

Stephen Miller

“Sticky” services inflation, a still elevated core inflation result for September and a slightly higher than anticipated headline number means that a further increase in the policy rate remains on the agenda for future meetings of the Federal Reserve Federal Open Market Committee (FOMC).

The totality of the September consumer price index (CPI) report will reawaken fears that renewed momentum in the economy is leading to some reignition of price pressures. That may lead markets to question whether the Federal Reserve (Fed) could successfully “thread the needle” and engineer a relatively benign disinflation (so-called “immaculate disinflation”) without an excessive dislocation in activity and employment.

Even if the Fed were to hold any policy rate hike in abeyance, it 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. Financial markets had anticipated cuts a little earlier than that.

In annual terms, headline inflation remained at 3.7 per cent in September with the higher than anticipated result mostly reflecting a jump in gasoline prices and housing. Core CPI fell to a still elevated 4.1 per cent from 4.3 per cent from in August, its lowest since September 2021.

Measures of the ‘inflation pulse’, however, indicate some recent “stickiness” in inflation suggesting that disinflationary forces evident in the first half of the year have stalled somewhat.

The 3-month annualised core CPI was 3.1 per cent in September, up from 2.4 per cent in August. The 3-month annualised Cleveland Fed trimmed-mean measure rose to 3.7 per cent in September from 2.9 per cent in August and was the highest since April. The Cleveland Fed median measure rose to 4.0 per cent from 3.6 per cent in August.

The September report will also reinforce ongoing concern at the Fed regarding the “stickiness” of services inflation. The 3-month annualised rate of services inflation (or ‘pulse’) increased to 5.2 per cent, the highest since March. A similar ‘pulse’ measure for services less energy jumped to 5.4 per cent for September from 4.0 per cent in July. Finally, the same measure for services ex-rent of shelter (a particular favourite of Fed Chair Powell) rose to 5.2 per cent from 3.3 per cent in August, the highest result since January.

So for the time being at least the policy rate is at best at a “plateau” rather than a “peak”.

The Fed’s mainly “hawkish” disposition is in some measure 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 it may be that the Fed was concerned not to excite too much market exuberance to a policy rate “skip”, hence the frequent attachment of “hawkish” riders. Certainly, to the extent that bond yields remain at levels not seen since 2007 in the pre-Financial Crisis era means that the Fed has been successful in this endeavour, giving it time to assess whether the policy rate hikes to date are sufficient to return inflation to target within a reasonable timeframe.

But despite the rise in bond yields, the overall tone of the September report should keep markets alert to the possibility of further hikes in the policy rate.

NAB Monthly Business Survey leaves open the prospect of further rate hikes

At the conclusion of this month’s Reserve Bank of Australia (RBA) Board meeting, the Governor’s Statement noted that “recent data are consistent with inflation returning to the 2–3 per cent target range over the forecast period.” (My emphasis)

However, the backward focus on recent data does little to assuage nascent anxieties that inflation in Australia will prove to be “sticky” enough to force the RBA’s hand later in the year or early next.

And that a rate rise in October was too difficult for the RBA to prosecute doesn’t mean that there is not a prosecutable case, one based on the data pipeline.

The Governor’s Statement appears to acknowledge this noting that “some further tightening of monetary policy may be required to ensure that inflation returns to target in a reasonable timeframe.”

The August monthly CPI showed a reacceleration of inflation from July. Of some concern too would have been the “stickiness” evident in the services sector.

The NAB Monthly Business Survey on Tuesday revealed some re-acceleration in wages and prices in the quarter, although to be fair that acceleration waned 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) data then policy rate increases could well be back on the agenda as early as the next meeting on 7 November.

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.

Those upside risks are put in stark relief by a continuing poor productivity performance. Even with relatively modest wage growth, according to the most recent national accounts data, unit labour costs (the most relevant labour cost gauge for inflation) are growing at over 7 per cent per annum. As the Governor’s Statement noted “wages growth […] is still consistent with the inflation target, provided that productivity growth picks up”. (My emphasis)

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.

In other words, future data may well look different to the arguably fortuitous character of the recent data, leaving the way open for further policy rate hikes into year-end and beyond.