Stephen Miller
A slightly better than expected core consumer price index (CPI) inflation result for October suggests that the Fed tightening cycle is likely in abeyance – probably indefinitely.
The Federal Reserve (Fed) will have the benefit of one more monthly CPI read for November before it meets in December. However, with inflation now appearing to be tracking a little better than the Fed’s September projections, and with some tentative signs that inflation is declining, it is difficult to see a number that might cause the Fed to enact a rate hike at its final meeting for 2023.
However, even with that abeyance, I expect the Fed to retain its “high for longer” mantra meaning that any policy rate cuts are well into 2024. Nor is it obvious to me that the Fed would contemplate any reduction in the policy rate in accordance with some of the more aggressive projections in the marketplace. Indeed, it appears to me that the extent of easing currently priced into markets – while not implausible – implies a policy rate through 2024 that is located at the low end of the risk continuum.
The Fed’s “high for longer” mantra is a device to forestall a further easing in financial conditions. Until recently, 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, but with that exuberance showing signs of reasserting itself, the Fed would be applied in not allowing such exuberance to undermine the hard-won gains to date in containing inflation.
In annual terms, headline inflation fell to at 3.2 per cent in October from 3.7 per cent in September aided by a sharp fall in gasoline prices. Core CPI fell to 4.0 per cent from 4.1 per cent from in September, its lowest since September 2021.
However, the report is not quite as benign as the market reaction would have it.
Measures of the ‘inflation pulse’, however, indicate some ongoing “stickiness” in inflation.
The 3-month annualised core CPI was 3.4 per cent in October, up from 3.1 per cent in September and 2.4 per cent in August. The 3-month annualised Cleveland Fed trimmed-mean measure rose to 3.8 per cent in October from 3.7 per cent in September and 2.9 per cent in August and was the highest since April this year. The Cleveland Fed median measure rose to 4.5 per cent from 4.0 per cent in September and 3.6 per cent in August.
The October report may 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 5.3 per cent, the highest since March.
Despite the grudging progress on inflation, indications of ongoing “stickiness” will make Fed officials properly wary of declaring “mission accomplished” on inflation, hence the maintenance of the “high for longer” mantra.
In other words, the policy rate is best viewed as at a “plateau” rather than a “peak”.
RBA: a December policy rate hike looks unlikely
Tuesday’s NAB Survey made for a vaguely positive read: business conditions are proving resilient, and wage and inflation indications show signs of dissipating, albeit at a grudging pace.
Subject to what the September quarter wage price index (WPI) reveals, I’m not convinced that the RBA will follow through with another policy rate hike in December. In my view, if one were to occur it is more likely at the 6 February meeting next year.
The Governor’s Statement following the November rate increase was a well framed and appropriately nuanced statement which gave the Board maximum optionality going forward.
In a highly uncertain global and domestic environment, the articulation of that optionality is entirely appropriate.
Financial markets crave guidance from central banks. In their craving for such guidance, however, they often lack appreciation of the limitations on central banks in the provision of such guidance. That is not simply the case in the current circumstance where “known unknowns” are particularly manifest but also in normal circumstances where “unknown unknowns” are omnipresent.
Too often, central bank communication has ignored this and attempted to sate the markets’ craving.
It was that circumstance that blotted the previous Governor’s copybook.
The incoming Governor has avoided that mistake.
There are clear risks that inflation may be even more intractable. But importantly, those risks are almost (but not quite) symmetric with risks that any slowdown and attendant disinflation obviates the need for further monetary tightening.
On the potential for further “stickiness” in inflation, central bankers around the world have remarked on the “stickiness” of service price inflation. 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).
There are some other domestically driven troublesome inflation portents. Recent changes in the regulatory environment in Australia, particularly in relation to the wage-setting and the industrial relations framework, potentially exacerbate an already stubborn inflation problem. By weakening the link between productivity and nominal and real wage growth, those measures run the risk of entrenching higher inflation in Australia compared to elsewhere particular.
The Governor noted in her Statement following the November rate increase that “wages growth … is still consistent with the inflation target, provided that productivity growth picks up”. (My emphasis). That looks like a big “if”!
Wage increases are digestible in times of reasonable productivity growth. However, productivity growth in Australia has been abjectly poor and even with relatively modest wage growth, the most recent (if dated) figures show unit labour cost growth (the most relevant labour cost gauge for inflation) is running at over 7 per cent per annum.
By contrast, the current annual rate of unit labour cost growth in the US is 1.9 per cent with the difference mostly attributable to productivity growth. That is why the Fed can contemplate an end to its rate hiking cycle while the RBA needs to be a little more circumspect.
The interplay between productivity and wage growth are domestic developments upon which the RBA will cast a keen eye.
The Statement from the Governor doesn’t rule out the possibility of a further increase. That said, it is clear that any decision to further increase the policy rate is data dependent.
Important in this regard will be the September quarter wage price index released on 15 November (likely high, but potentially boosted by a number of one-offs, and probably addressed by the November rate hike). The September quarter national accounts which (a little unhelpfully) are released a day after the RBA Board’s December meeting on 6 December are also important not just because of the conventional measures of economic activity growth that they provide but also for wage, productivity and unit labour cost indications. Finally, the December quarter consumer price index on 31 January also looms as a key staging post in determining whether another policy rate hike is appropriate.
Also important, will be unfolding developments in China which were given explicit reference in the Governor’s Statement and which continue to remain troublesome.
That probably means that the next window for a policy rate hike will not occur until the February RBA Board meeting on 6 February, and then only if unit labour cost growth and inflation refuse to show indications of meaningful decline or prospects thereof.