Stephen Miller
Yesterday’s June labour force is potentially pivotal in deciding which way the Reserve Bank of Australia (RBA) Board jumps at its meeting on 5-6 August.
At this stage my best guess is that the RBA will be persuaded to adjust the policy rate higher in August given my expectation that annual trimmed-mean inflation will have a “4 handle” when the June quarter consumer price index (CPI) is released on 31 July.
The consensus (but certainly not universal) narrative is that underlying weakness in activity growth will show through in a weaker labour market and allow a more confident projection of inflation declining in a timely fashion toward target and that, accordingly, the RBA Board will stand pat at the August meeting.
The latter part of that view – that there can exist a confident projection of the timely return of inflation back to target – looks a challenge, certainly relative to the manner envisaged by the most recent RBA forecasts.
The former part (a weakening labour market) will likely come to pass, although the current evidence is at best piecemeal. And should a weakening labour market come to pass, the extent and rapidity with which it does so is important.
At this stage it seems likely that the unemployment rate will be close enough to the RBA May projection to allow inflation concerns to dominate any concern about a dramatically weakening labour market when it comes to the decision on whether to increase the policy rate in August.
RBA Governor Bullock has noted that the Board needs “a lot to go its way” to get inflation back to target in a manner consistent with the RBA’s inflation projection.
My concern is that “a lot is going the other way”.
The current RBA forecast issued in May is for trimmed-mean inflation in the year to the June quarter to be at 3.8 per cent. That was upwardly revised from the previous forecast in February.
As noted, that forecast is likely to be exceeded when the June quarter CPI is released on 31 July, and non-trivially so with a “4 handle” probable.
Of course, the RBA has a dual mandate that relates to minimising unemployment as well as inflation containment.
Therefore, the RBA might avoid raising the policy rate in August if today’s data reveals excessive dislocation in the labour market.
Consensus expectations are for an increase in employment around 20-25k and for the unemployment rate to remain unchanged at 4 per cent or perhaps edge a little higher to 4.1 per cent.
In my view, it would take an outcome significantly worse than the consensus for the RBA to eschew a policy rate hike. That would be a significant fall in employment (greater than 25k) and an unemployment rate at 4.3 per cent or greater. Anything between that and the consensus (say where employment growth comes in between -25k and 15k and the unemployment rate at 4.2 per cent) probably winds the policy rate hike odds back to 50/50. The consensus or better means a policy rate hike remains more likely than not.
If there is a lesson to be drawn from the intractable inflation of the 1970s, it is that too great a 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 of a more damaging macroeconomic dislocation in terms of activity and employment down the track.
We are admittedly a long way from that 1970s experience, and that reference is not a criticism of the worthiness of the RBA “experiment”.
However, that experiment now needs to incorporate a further hike in the policy rate to a level that in any case will still be below many central bank peers – a timely “tweak” within the context of the continuing “experiment”.
The RBA’s inflation containment task has also been frustrated by counter-productive government policies.
In the Australian context the arrangements attaching to wage-setting and industrial relations regulation have complicated the RBA task and the Future Made in Australia measures may well do so.
Fiscal policy in Australia, mostly – but not exclusively – at the state government level has not helped.
Westpac research has shown that net government spending would increase aggregate demand by a chunky 2.2 percentage points of gross domestic product (GDP) in 2024-25, thanks largely to big-spending state governments erroneously purporting to provide cost-of-living “relief”.
With excess demand a primary driver of inflation, that government contribution is problematic, at least those elements that don’t have attenuating and near-term supply-side effects (which arguably the income tax cuts do).
What they do, however, is give the RBA some ability to adjust the policy rate without tipping the economy over the edge.
An unkinder interpretation is that fiscal laxity has exacerbated inflation pressures and led at the very least to a delay of interest rate relief and at the most an attendant increase in pressure on households with mortgages through yet higher interest rates.
The Board Statement following the June meeting emphasised “the need to remain vigilant to upside risks to inflation.” It had previously expressed “limited tolerance for inflation returning to target later than 2026.”
For those statements to mean anything – and assuming today’s numbers are within range of the consensus expectation and trimmed mean inflation has a “4 handle” come the June quarter – it will be difficult to avoid a policy rate hike when it meets on 5-6 August.
New Zealand/Canada/UK CPIs
New Zealand (NZ)
The NZ June CPI was certainly better than expected with a headline number of 3.3 per cent down from 4 per cent in the March quarter. The consensus expectation was for 3.4 per cent while the (somewhat dated) Reserve Bank of New Zealand (RBNZ) forecast was for 3.6 per cent. That might have ordinarily excited hopes for a policy rate cut when the RBNZ meet on 14 August. However, the detail behind the report paints a less benign picture. The closely watched non-tradables measure slowed to 5.4 per cent down from 5.8 per cent in the March quarter but remained marginally above the RBNZ projection of 5.3 per cent.
The “stickiness” of domestic (non-tradable) inflation probably means that any cut in the RBNZ’s policy rate from 5.5 per cent will not occur until November at the earliest. That would give the RBNZ the benefit of a further quarterly inflation report.
Canada
The Canadian CPI report was probably satisfactory enough for the Bank of Canada to again cut rates when it meets on 24 July, taking the policy rate to 4.5 per cent (it also cut rates at its last meeting on 5 June). The average of the Bank of Canada’s favoured median and trimmed-mean measures fell more or less in line with expectations by 0.1per cent to 2.75 per cent. The headline number fell to 2.7 per cent from 2.9 per cent and while that 2.7 per cent might be marginally more than expected, it confirmed that inflation is declining toward the 2 per cent target. Certainly, markets are enthused by the prospect of a further policy rate cut rating the probability of such a move at close to 90 per cent.
UK
Last night’s June UK CPI figures make the Bank of England meeting on 1 August a bit of a lineball call.
Headline inflation looks satisfactory enough coming in at 2.0 per cent versus 1.9 per cent expected and 2.0 per cent in May. Core inflation, however, remains some distance from the target coming in above expectations at 3.5 per cent versus the 3.4 per cent expected and 3.5 per cent in May.
More worryingly, services inflation – which has garnered special attention from the Bank of England (BoE) – was unchanged at a still elevated 5.7 per cent compared with a BoE projection of 5.1 per cent.
There is an argument that given the patently exhibited inflation proclivities of the UK economy for waiting until the meeting on 19 September before contemplating a cut in the policy rate from its current 5.25 per cent.
Those proclivities include:
- Stronger worker resistance to real wage erosion. These were in evidence in the April wage numbers showing ongoing strong wage growth (5.9 per cent including bonus; 6.0 per cent ex-bonus).
- 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.
But the BoE was also complicit in the UK’s relatively poor inflation performance, early in the piece exhibiting not a small amount of prevarication in assuming a frontline role in fighting inflation.
While the unemployment rate has been remarkably resilient at 4.4 per cent a premature easing might see unduly “sticky” inflation potentially occasioning a greater and more disruptive dislocation in employment and activity down the track.
Tonight brings forth more wage data but it will take a sharp move down from the current 6 per cent pace to establish any confidence that services inflation can decline in a manner that provides any confidence that inflation can remain meaningfully in touch with the 2 per cent target.
That is a strong argument to exercise patience in contemplating any policy rate cut. I am not convinced the BoE shares that view. The markets have tempered their own views on the possibility of a policy rate cut taking the odds to around 30 per cent in the wake of the CPI release from closer to 50 per cent prior.
Any Australian implications?
The forgoing presents little by way of a template for Australia where the policy rate is significantly lower, inflation is higher and the unemployment rate lower than in NZ, Canada and the UK. In other words, idiosyncratic elements will (should) be the bigger driver of RBA Board deliberations.
Coming up: ECB to stand pat but leave the door wide open for September
While inflation in the Eurozone has been on a meaningful downward trajectory for some time, there are residual indications of “sticky” inflation, particularly in the services sector – persistent and pervasive (cyclical and structural) headwinds to activity growth notwithstanding. The June Eurozone CPI report showed the core harmonised index of consumer prices (HICP) grew by 2.8 per cent over the year (still some way from the 2 per cent target). Services HICP, however, grew by 4.1 per cent mostly reflecting continued elevated wage growth.
Further, and while European political developments will not play directly into the European Central Bank (ECB) calculus, a continued creeping populism in economic policy may make the ECB’s inflation containment task all the more difficult in the future. At the margin that may see the ECB err on the side of caution when it comes to further policy rate adjustments.
At its last meeting the ECB cut its various policy rates (deposit facility, main refinancing operations and marginal lending facility) by 25 basis points to 3.75 per cent; 4.25 per cent; and 4.50 per cent respectively.
This time around, I suspect that the “stickiness” in the services sector probably means the ECB leaves its policy rates unchanged at tonight’s meeting.
However, I expect that ECB President Christine Lagarde in any commentary to seek to retain maximum optionality with regard to future downward adjustments and that subject to inflation continuing to decline toward the 2 per cent target, the ECB will further cut the various policy rates at the 12 September meeting.
By Stephen Miller, investment strategist
