RBA and September quarter national accounts: historical curiosum or troubling portent?


Stephen Miller

Wednesday’s September quarter national accounts release did not make for a pleasing read. Growth was slow (probably slower than the Reserve Bank of Australia (RBA) forecast) but inflation remains high, albeit consistent with indications from the September quarter consumer price index (CPI) release. Productivity growth recovered in the quarter but strong growth in labour costs saw unit labour costs increase by 2.2 per cent in the quarter to remain at an elevated annual 6.4 per cent.

In short the picture painted is one of a low growth economy with high inflation.

In my view that represents in part some underachievement in policy formulation. The RBA bears some (but certainly not sole) responsibility for this by showing too great a tolerance for inflation, at least early on in the inflation upswing. Fiscal policy (mostly at the state government level) has not helped, while any propensity for governments to initiate meaningful structural reform is a memory from decades ago.

Nevertheless, for some observers, the September quarter national accounts are a bit of a historical curiosum: they don’t really add a lot to our stock of knowledge on the economy beyond a confirmation that growth was tepid and inflation still troublingly high and, in any case – so the narrative goes – the fact that the RBA raised the policy rate in November means policy has already responded to the inflation challenge.

There is a kernel of truth in that, but only a kernel.

There are elements of the national accounts, particularly with respect to labour cost growth and productivity growth, that remain portentous of some continuing challenges to inflation containment.

In her Statement following the December 5th RBA Board meeting which kept the policy rate unchanged at 4.35 per cent, RBA Governor Michele Bullock noted that “wages growth…remains consistent with the inflation target, provided productivity growth picks up.” (My emphasis). That phrase has appeared in Statements now for some months.

As I’ve noted in the past, that is a critical assumption. And despite some signs of a recovery in productivity in the September quarter, the assumed ongoing pick-up in productivity growth remains a critical assumption.

With annual unit labour cost growth (the most relevant labour cost gauge for inflation) at 6.4 per cent, it remains difficult to project any abatement of the “stickiness” in inflation beyond that projected by the RBA in its most recent set of forecasts issued in November. (By contrast, figures released overnight show the current annual rate of unit labour cost growth in the US is 1.6 per cent with the difference mostly attributable to productivity growth. Wage growth is much the same in both economies.)

By retaining a moderate tightening bias, the RBA seems to implicitly acknowledge the challenge of getting unit labour cost growth down via productivity growth, albeit that the tightening bias is conditional on how economic data may unfold and any attendant risk assessments based on that data.

It is also clear that after an extended period where the RBA tolerance for an elongated return of inflation to target has been much greater than other developed country central banks, that tolerance well is now pretty dry.

In a highly uncertain global and domestic environment both the tightening bias and the articulation of conditionality is entirely appropriate and while I would not regard the recent RBA inflation forecasts as unrealistic, in my view, the balance of risks remains that inflation may prove a little more intractable.

Wage increases are digestible in times of reasonable productivity growth. However, and despite the silver lining evident in the productivity cloud in the September quarter, annual productivity growth in Australia remains abjectly poor and current unit labour cost growth is incompatible with inflation returning to target along the path articulated by the RBA forecasts.

The productivity challenge is given some poignancy by recent changes in the regulatory environment in Australia, particularly in relation to the wage-setting and the industrial relations framework. These changes potentially exacerbate an already stubborn inflation problem. For one thing they are broadly inimical to productivity growth and for another they weaken the link between productivity and nominal and real wage growth. Such measures run the risk of entrenching higher inflation in Australia compared to elsewhere particular.

The interplay between productivity and wage growth are therefore domestic developments upon which the RBA will cast a keen eye.

Central bankers around the world have also remarked on structural sources of “stickiness” in global 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).

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. An unwillingness to tackle housing supply entrenches this problem.

As extant as these risks are, there are some going the other way with risks that any slowdown and attendant disinflation obviates the need for further monetary tightening.

Also important will be unfolding developments in China which were again given explicit reference in the Governor’s December Statement.

However, in my view the February RBA Board meeting on 6 February remains “live”. The September quarter CPI released on 31 January looms as a key staging post in determining whether another policy rate hike is appropriate.

Finally, in my view Governor Bullock has applied herself well to the framing and nuancing of RBA communication.

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 manifested but also in normal circumstances where “unknown unknowns” are omnipresent.

In this context, Governor Bullock’s articulation of the conditionality in any RBA guidance and of the balance of risks is noteworthy and appropriate.

Too often, central bank communication has ignored this and attempted to sate the markets’ craving.

Moreover, and despite some excitable and mostly confected outrage in some sectors of the media and market commentariat – mostly reflecting an incapacity for nuance – her direct message to the broader community regarding the inflation challenge welcome, providing as it does a secure anchor for inflation expectations.

Coming up: US non-farm payrolls

The November US monthly non-farm payrolls report to be released on Friday will of course be keenly watched.

Bond markets have rallied hard since the US 10-year hit a late October peak close to 5 per cent. In large measure that reflects a belief that the Federal Reserve (Fed) will cut the policy rate by something close to 125 basis points next year with something close to 50 basis points priced in the first half of 2024.

The most recently issued Fed “dot plot”, however, implies at least further increase in the policy rate this year, although that is likely to be revised away when the Fed issues a new “dot plot” after the conclusion of next week’s FOMC meeting.

A key feature of the current tightening cycle has been that markets have keenly anticipated policy rate cuts only to be disappointed.

At this juncture the anticipation of cuts in the policy rate are probably more credible than prior episodes dating from 2021, but the tone in markets in terms of the extent and timing of cuts to the policy rate seems a long way from the tone of recent Fed communication, including from Fed Chair Jerome Powell.

Of course, the Fed is not always a good forecaster of its own actions and the cuts priced do not reflect implausible scenarios, even if the assumed path of the policy rate is located at the low end of the risk spectrum. However, a more critical narrative might suggest that bond market participants have repeatedly ignored the context of the current tightening cycle: that it was occurring against a background of an inflationary shock and where levels of monetary accommodation were at historically unprecedented levels. That may reflect that many market participants had little experience with any meaningful inflation shock and lacked an appreciation of just how difficult it is for central banks to effectively contain such a shock with the most recent precedents date back to the 1970s.

As the self-described “aged” 1970s ruminator, Niall Ferguson, wrote 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 compromise on the part of a central bank in the execution of 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.

Fed Chair Powell has recently characterised the state of labour market as close to “what we want to see.”

As important as the payrolls data are, in the absence of a report a long way from expectations, it will be progress on inflation that will determine whether the Fed chooses to enact any policy rate cuts.

In this context, markets will likely be particularly exercised regarding the extent to which the November report reveals some tempering of wage pressure as well as focussing on conventional measures of employment growth and the unemployment rate. Decelerating wage growth would encourage a more positive narrative on inflation abatement and a more positive backdrop for financial markets and vice versa.

The consensus estimates for November non-farm payrolls are for an increase in employment of around 180k (perhaps boosted a little by returning auto workers), an unchanged unemployment rate at 3.9 per cent, and for average hourly earnings to slow to 4.0 per cent annual growth from 4.1 per cent in October.

The October Job Openings and Labour Turnover Survey (JOLTS) report released on Tuesday indicated some degree of softening in the US labour market, but nothing that would alarm the Fed nor lead Fed Chair Powell to revise his characterisation of the labour market.

Also important was the employment component of the Institute for Supply Management (ISM) Purchasing Managers Index (PMI) for services, released on Tuesday. That component remained in expansionary territory.

The ADP payrolls report released overnight is consistent with ongoing softening of the labour market with employment growing only 103k (versus an expected 130k). While a reasonable enough indicator in and of itself, its record in foreshadowing month-to-month movements in the Bureau of Labor Statistics payrolls measure is at best mixed.

An outcome close to expectations for the aforementioned components of the non-farm payrolls report won’t move the dial for the Fed to where markets reside.

The real test comes next week with the release of the September US CPI next week.

Markets have been gripped by optimism on the inflation front.

And while the Fed’s favoured core PCE price index was better than expected in October and the CPI looked benign enough, it appears way too early to declare “mission accomplished” as financial markets seem want to do.

For example, 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 while the 3-month annualised rate of services inflation (or ‘pulse’) increased to 5.3 per cent, the highest since March. Finally, the “prices paid” component of the November ISM remains elevated at 58.3 – a long way from foreshadowing any decline in service sector inflation. The ISM manufacturing “prices paid” index jumped sharply in November to 49.9 from 45.1 which casts some doubt on the emergent “goods deflation” narrative.

The November CPI is released on Tuesday ahead of the conclusion of the final Fed FOMC meeting for the year.

The minutes from the last FOMC meeting noted that while all officials agreed that the FOMC was in a position to “proceed carefully”, they all thought it was appropriate to keep rates restrictive “for some time until inflation is clearly moving down sustainably” (my emphasis). Moreover, most officials continued to see upside risks to inflation. That meeting took place when US 10-year bond yields were close to 5 per cent; they are now some 80 basis points lower than that so financial conditions are now significantly easier from those that prevailed at the time of the meeting.

That means that the Fed itself believes that it is still some way from contemplating any policy rate cuts – probably not until the second half of 2024. In that context the extent of easing currently priced into markets – while not implausible – implies a policy rate path through 2024 that is located at the low end of the risk continuum.

Bank of Canada: stand-down, job done…maybe!

As was largely anticipated the Bank of Canada (BoC) left its policy rate unchanged at 5 per cent. However, the BoC left the door open for further increases in the policy rate should progress on reducing inflation stall. BoC also expressed an intention to press on with balance sheet normalisation (“quantitative tightening”).

Despite an acknowledgement that economic growth had appeared to stall, and that the economy was no longer in “excess demand”, the BoC Governing Council remained “concerned about risks to the outlook for inflation and remains prepared to raise the policy rate further if needed”.

An earlier muscular approach to monetary policy has seen trimmed-mean inflation decline to around 3.5 per cent in October (compared with 5.2 per cent in Australia). The Bank itself noted that in recent months, its preferred measures of core inflation have been around 3.5-4 per cent, with the October data coming in towards the lower end of this rang. The 6-month annualised “pulse” measures for inflation present an even more benign picture, running within the BoC’s wide 1-3 per cent inflation target, though the BoC does emphasise the 2 per cent mid-point.

In this context, a further increase in the policy rate looks unlikely. Markets still expect the BoC to commence cutting rates in April and see close to a 100 basis points of easing in 2024. That is well ahead of where the BoC is.

Similar to the Fed, the BoC are attempting to push back against policy rate cut speculation which would ease financial conditions and make their inflation-fighting job more difficult. As with the Fed markets are ignoring the message.

By Stephen Miller, investment strategist 

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