Stephen Miller
I’m not sure that there was a lot of information in the Reserve Bank of Australia (RBA) June minutes released on Tuesday.
The minutes are best viewed as the reasoning behind the decision to leave the policy rate unchanged at the June meeting. In that sense they are a little backward-looking.
Tellingly, however, the minutes noted the “increased…risk that sustainable progress towards the inflation target may be slower than forecast”.
In my view those risks have intensified since the June meeting.
Partial information since that meeting from the May NAB monthly business survey and from the May monthly consumer price index (CPI) indicator not only suggests inflation is “sticky” but perhaps “stuck” at 4 per cent.
RBA Deputy Governor Hauser has said it would be a mistake to change policy on one number.
What he didn’t say (but would presumably concur with) is that it would be folly to ignore serial indications of sticky inflation.
I had thought (without a great deal of conviction) that a further policy rate hike was unlikely. That was based on a view 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.
The first part of that premise (a weakening labour market) will likely come to pass, although the current evidence is piecemeal at best. Stronger retail and building numbers for May released yesterday provide further modest support for that notion.
The second – that there can exist a confident projection of the timely return of inflation back to target – looks under extreme challenge, certainly relative to the manner envisaged by the most recent RBA forecasts.
The RBA minutes confirmed that the case for a policy rate hike was discussed at the June meeting but the case for a reduction was not.
Further, 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.
The May CPI indicator suggests that “a lot” is going the other way.
The RBA’s task has 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).
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.
The impact of those government measures will be felt in future quarters rather than the June quarter.
But even in the June quarter the RBA forecast is likely to be exceeded (as was its March quarter forecast), and maybe non-trivially so with a “4” handle a distinct possibility.
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, the likely event of a higher than forecast June quarter CPI will make it difficult to avoid a policy rate hike when it meets on 5-6 August.
Fed FOMC minutes: not yet but coming this year
As with the RBA minutes there was not a great amount of revelation in the Federal Reserve’s (Fed) FOMC minutes from the 11-12 June meeting.
In essence, the minutes revealed that the FOMC members were awaiting additional evidence that inflation is cooling but were open to at least one policy rate reduction this year.
Recall that these minutes relate to the meeting where the Fed issued a revised “dot plot” that wound back the median expectation for policy rate cuts for 2024 from three 25 basis point (bp) reductions to just one such reduction by end-2024. That took the median projection to 5.1 per cent from 4.6 per cent back in March.
The minutes noted that “several” participants thought a further weakening in demand could generate a larger increase in unemployment while “some” officials emphasised the need for patience. (Like the RBA, the Fed has a dual mandate focussed on inflation and unemployment). That said, “several” policymakers maintained a willingness to raise interest rates should inflation remain elevated.
Interestingly, the minutes noted that some officials “remarked that the continued strength of the economy, as well as other factors, could mean that the longer-run equilibrium interest rate was higher than previously assessed, in which case both the stance of monetary policy and overall financial conditions may be less restrictive than they might appear”. That might point to only a very gradual decline in the policy rate once the Fed starts moving in that direction. However, New York Fed President Williams speaking at the European Central Bank’s (ECB) Sintra Forum, appeared to push back on this notion arguing that he thought the neutral rate hadn’t risen much.
In his press conference subsequent to the June meeting, Fed Chair Powell asserted that with the newly issued “dot plot” the Fed was “not trying to send a strong signal” on its intentions regarding the course of the policy rate and remained “very data dependent”.
In remarks on Tuesday evening at the ECB’s Sintra Forum, Powell reiterated his guarded endorsement of the likelihood of a Fed policy rate cut this year, saying that there had been “quite a bit of progress” in reducing inflation but added that the Fed would need to see a continuation of that progress before it could contemplate a cut in the policy rate. He added that because “the US economy is strong and the labour market is strong, we have the ability to take our time and get this right”.
That to me suggests that given what the Fed knows, and, importantly, absent any huge data surprises, it is still some way from contemplating a near-term policy rate cut.
However, given growing evidence of some softening in the economy there will almost certainly now be at least one policy rate cut this year.
The next key data staging posts are the non-farm payrolls on Friday and the June monthly CPI to be released next Thursday.
The payrolls data comes after a number of signs overnight of further cooling in the labour market.
Markets will likely be particularly exercised regarding the extent to which the June report reveals any tempering of wage pressure as well as focussing on conventional measures of employment growth and the unemployment rate.
May revealed an upside surprise in wage growth that threatened to derail a more positive narrative on inflation abatement. In the event the May CPI and Powell’s mostly soothing commentary post-FOMC put paid to those concerns. However, a further upside surprise may see a “sticky” inflation concern again rear its head.
The consensus estimates for May non-farm payrolls are for an increase in employment of around 190k, an unchanged unemployment rate at 4.0 per cent, and for average hourly earnings to decelerate to around 3.9 per cent annual growth.
The May Job Openings and Labour Turnover Survey (JOLTS) report released on Wednesday were stronger than anticipated and while maybe not inconsistent with some ongoing cooling in the US labour market they remain some way from signalling any worrying dislocation.
More worrying from a labour market perspective was the employment component of the June Institute for Supply Management (ISM) Purchasing Managers Index (PMI) for services released overnight. That component lurched deeper into contractionary territory to 46.1 down from 47.1 in May. The overall index also fell into contractionary territory to 48.8 from 53.8 in May – the weakest since May 2020.
The ADP June payrolls report released overnight are consistent with modest ongoing softening of the labour market with employment growing by 150k (versus an expected 160k). 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 that much for the Fed. As stated earlier, it probably leaves it contemplating a rate cut at some stage beyond the July FOMC meeting with some possibility of a second such cut before year-end.
A bigger test comes next week with the release of the June US CPI on Thursday next week.
ECB: stuck between elections and a hard place
Not that the French elections will play directly into the ECB calculus, but to the extent there is a theme it is that a more populist economic agenda will make the inflation containment task all the more difficult.
It may also complicate the transmission mechanism for monetary policy as it ripples through individual country bond markets, particularly the French market, if spreads there were to widen versus German bonds.
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.
Overnight, speaking at the ECB’s Sintra Conference, Greek ECB Governing Council Member Stournaras suggested “two more rate cuts this year seems reasonable and consistent with our forecasts” adding that in his view the ECB was still in “highly restrictive territory and will continue to be even if we have two more cuts this year.”
Other members of the Governing Council would likely display a little more circumspection.
ECB President Christine Lagarde, speaking at the same conference said this week that the services gauge doesn’t have to hit 2 per cent since its elevated readings can be offset by other components, but she stopped well short of endorsing two more policy rate reductions.
The ECB have had to confront further indications of “sticky” inflation, particularly in the services sector, at a time of persistent and pervasive (cyclical and structural) headwinds to activity growth. The June provisional 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.
That “stickiness” in the services sector probably means the ECB leaves its policy rates unchanged at its 18 July meeting.
By Stephen Miller, Investment strategist
