Stephen Miller
No real surprises from the Reserve Bank of Australia (RBA) May Board meeting minutes. Governor Michele Bullock had already let it be known that the Board debate was one of leaving the policy rate on hold or increasing it.
In the end the Board opted to leave the policy rate unchanged but indicated it was “very alert” to the cost of stubbornly high inflation lingering. It also added that and the risks ahead were “balanced” but that “the costs associated with them could be asymmetric”, referring to the corrosive impacts of inflation on household income and wealth.
It also indicated it wanted to “avoid excessive fine-tuning” of monetary policy in response to “short-term variation” in inflation. That indicates patience with what it may regard as “noise” in inflation indicators, particularly at a time when weak household spending is likely to be reflected in a weakening labour market.
The Board Statement post the May meeting referenced “particularly weak” household consumption and added “there is a risk that household consumption picks up more slowly than expected, resulting in continued subdued output growth and a noticeable deterioration in the labour market.” (My emphasis.)
That goes to the heart of the RBA’s dual mandate of inflation at target and minimising unemployment.
Developments since the meeting are consistent with some softening of the labour market so in the short-term at least that apparent patience has arguably been vindicated.
Nevertheless, given the Board’s “limited tolerance for inflation returning to target later than 2026” a further upside surprise in inflation may yet elicit a further policy rate hike.
I continue to regard a further hike as unlikely given underlying weakness in activity growth will eventually show through in a weaker labour market and inflation declining toward target.
The most likely scenario is an extended pause in any policy rate adjustment until the RBA is convinced that its current trajectory for the return of inflation to target is secure. That argues for a policy rate cut toward the end of the year or sometime in the first half of 2025.
A sharper than anticipated slowdown resulting in a greater than anticipated dislocation in the labour market may bring the timing forward a little but as yet there is little sign of that occurring.
The reality is that those of us who were not long ago anticipating a policy rate reduction this year may have to cool their heels for a while yet.
So might a government that heretofore had been anxiously anticipating a pre-election policy rate decline.
Fed: patience through the “noise” or waiting for Godot II
In a somewhat similar vein to the RBA, the Federal Reserve (Fed) FOMC minutes from the meeting ending on 1 May also signaled a declining level of patience with the rapidity with which inflation is declining, but at the same time indicated some reluctance to embrace a further policy rate hike.
Members saw policy as “well positioned,” even if various officials mentioned “a willingness to tighten policy further…should risks to inflation materialise in a way that such an action became appropriate.” Even given that willingness, it seems doubtful, in the absence of a sizeable upside surprise in inflation, that the Fed is close to contemplating any further increase given “many” Fed officials noted policy “was seen as restrictive”.
The markets may be tempted to downplay the apparent hawkishness of the minutes given that it seemed to regard the latest US inflation print as evidence of a meaningful decline in inflation.
However, as Atlanta Fed President Bostic noted on Tuesday the modest improvement in inflation in April was “far from failing but not stellar.”
In that context, it might be that like the RBA, markets will need to wait until at least the end of the year or even until 2025 for a policy rate reduction.
RBNZ raises the prospect of a higher policy rate
The RBNZ’s anxiety regarding ongoing “stickiness” in inflation looks to be even greater than their trans-Tasman cousins.
The RBNZ chose to leave the official cash (policy) rate (OCR) rate unchanged at 5.5 per cent but issued an unambiguously hawkish statement to accompany that decision.
The statement confirmed that the RBNZ Monetary Policy Committee (MPC) “discussed the possibility of increasing the OCR at this meeting,” and added that the MPC also “agreed that interest rates may have to remain at a restrictive level for longer than [had been] anticipated” in February.
Perhaps more surprising was that the RBNZ’s updated forecasts show the average OCR peaking at 5.65 per cent this year compared to 5.60 per cent in its previous projections in February. That implies a 60 per cent risk of a policy rate hike.
Bank of Canada: skating toward easing; Bank of England: caught on a “sticky” wicket (and an election)!
Some contrasting consumer price inflation outcomes and, accordingly, contrasting monetary policy implications in Canada and the UK.
Canada
Canadian inflation printed on the low side of expectations. The Canadian trimmed-mean came in close to expectations at 2.9 per cent from 3.2 per cent in March while the median measure was slightly better at 2.6 per cent from 2.9 per cent in March.
The relative inflation success may in part reflect that the Bank of Canada (BoC) was relatively aggressive and stayed more consistently on message regarding its inflation containment objective.
Bank of Canada Governor Macklem has described the prospect of a policy rate reduction at the next meeting on 5 June as “within the realm of possibilities”.
Markets now assess that probability above even money, at something close to 60 per cent, from slightly less than even money prior to the inflation data.
My view is that the trend in inflation in Canada is sufficiently clear to enable the Bank to cut in June, albeit that commentary around any cut will be cautiously worded.
United Kingdom
Like the Fed and the RBA, the Bank of England (BoE) too find themselves confounded by much “stickier’ inflation than they or the markets had contemplated.
Complicating somewhat the BoE’s calculus, British Prime Minister Rishi Sunak overnight scheduled a General Election for 4 July.
The annual increase in core consumer price inflation came in at a still elevated 3.9 per cent, down from the 4.2 per cent recorded in March, but well above the expected 3.6 per cent.
The inflation comes after BoE Governor Bailey in an address at the London School of Economics (LSE) on Tuesday stated that the next move in the policy rate was a reduction but (wisely) refrained from putting a time frame on that.
He added that the BoE expected “quite a drop” in headline inflation to levels around its 2 per cent target when official numbers were released. He did get that with the headline rate falling to 2.3 per cent from 3.2 per cent but it was well short of the expected fall and the worrying “stickiness” in the core rate likely delays the consideration of a cut at the 20 June meeting.
After the release of the inflation data markets repriced the probability of a June rate cut to around 15 per cent, down from around 50 per cent prior to the inflation release.
It is not clear that the calling of the election should have any effect on the BoE’s decision-making process but some may feel that the BoE may be unwilling to adjust the policy rate during an election campaign which may reinforce the “high for longer” message from the inflation report.
Indeed, given inflation developments, it is possible that any rate cut may be delayed until the very end of the year or even 2025.
The UK economy exhibits some characteristics that suggest a greater inflation proclivity. These include :
- Stronger worker resistance to real wage erosion.
- Ongoing disruptions to external trading relations post-Brexit that have slowed supply chains and a lower degree of internal economic flexibility leading to productivity challenges.
- Limited government effort toward supply-side enhancement.
The latter two points were in large measure a consequence of the mismanagement of Brexit occasioned by a distracted (even indolent) Johnson Government and the turmoil wrought by the fleeting Truss Government. Their consequences are not helped by the political pressures confronting the Sunak Government.
The BoE was also complicit in the UK’s relatively poor inflation performance. Throughout 2022 it exhibited not a small amount of prevarication in assuming a frontline role in fighting inflation – less so in 2023.
However, with only grudging progress toward the inflation target from hereon in, and with wage and pipeline services inflation are still running at levels well in excess of those consistent with the sustained achievement of the target, the BoE may well struggle with “last mile” challenges.
