Stephen Miller
In a surprise to some (including this writer) the June quarter consumer price index (CPI) report didn’t reveal an excessive enough burst of inflation to elicit a further policy rate hike from the Reserve Bank of Australia (RBA).
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 CPI report revealed a number somewhat higher than the RBA forecast at 3.9 per cent.
However, weakness in activity growth will at some stage be reflected in a cooling of the labour market. That allows the RBA to more confidently project a timely enough return of inflation toward target. In that context, the “miss” in the RBA forecast is not sufficient to increase the policy rate when the RBA Board meets on 5-6 August.
At some level, the June quarter CPI report is a vindication of the RBA “experiment” in adopting a more cautious approach than its developed country peers in raising the policy rate. Such an “experiment” was aimed at minimising any dislocation in the labour market.
That appears to have been a success.
Markets certainly reacted positively to the report: bond yields fell sharply; stocks rallied, and the AUD (initially) gave up significant ground.
That said, challenges remain.
As worthy as the RBA “experiment” may have been, inflation is still indubitably “sticky” – more so than in the rest of the developed world.
That will probably mean that the RBA will need to be more cautious than its peers in lowering the policy rate. Indeed, a rate cut this calendar year remains in considerable doubt.
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 by making inflation “stickier” and increasing the non-accelerating inflation rate of unemployment or NAIRU.
The Future Made in Australia measures may well have a similar effect.
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 exercise patience in contemplating any downward adjustment to the policy rate.
An unkinder interpretation is that fiscal laxity has exacerbated inflation pressures and led to a delay of interest rate relief.
All said and done, however, the RBA and markets (and the Federal Government) will be breathing a sigh of relief in the wake of the June quarter CPI report.
Viva el experimento!
Fed: Let’s get this party started…almost
Former Federal Reserve Chair William McChesney Martin once described the role of the Federal Reserve (Fed) as akin to “to taking away the punch bowl just as the party gets going”.
Judging from the Federal Open Markets Committee (FOMC) meeting overnight and comments from current Fed Chair Powell the Fed is preparing for a September party.
In his press conference following the highly anticipated decision to leave the policy rate unchanged at its current 5.25-5.5 per cent target zone, Powell gave a strong indication that a such a cut would be on the table at the Fed’s September meeting. Powell noted that “[t]he question will be whether the totality of the data, the evolving outlook, and the balance of risks are consistent with rising confidence on inflation and maintaining a solid labour market…[i]f that test is met, a reduction in our policy rate could be on the table as soon as the next meeting in September.”
In its statement following the Fed meeting, the FOMC put some new emphasis on “both sides of its dual mandate,” rather than prior wording focused just on inflation risks. Specifically, the statement noted “that the risks to achieving its employment and inflation goals continue to move into better balance.”
And with inflation on a meaningful trajectory toward the 2 per cent target and with the labour market showing signs of cooling that is not surprising.
The Fed’s favoured inflation measure – the core private consumption expenditure (PCE) price index – is running at a 3-month annualised pace of 2.3 per cent. The Dallas Fed trimmed mean measure is also running at 2.3 per cent, the lowest since March 2021.
The most recent “dot plot” showed that the Fed’s median expectation for policy rate cuts for 2024 is for two 25 basis point (bp) reductions.
Powell sought to retain maximum optionality for policy rate adjustments noting that he “can imagine a scenario in which there would be everywhere from zero cuts to several cuts” over the remainder of the year, “depending on the way the economy evolves.”
But given likely developments in inflation and the labour market, the trajectory offered by the “dot plot” remains the most likely central case. It is, however, possible that an extra cut may come in this calendar year.
Powell added that a 50 bp cut was “not something we’re thinking about right now.”
The Fed meeting, and a heightened focus on labour market developments reinforces the focus on Friday’s payroll numbers.
The consensus estimates for July non-farm payrolls are for an increase in employment of around 175k, an unchanged unemployment rate at 4.1 per cent, and for average hourly earnings to decelerate to around 3.7 per cent annual growth.
The ADP June payrolls report released overnight are consistent with ongoing softening of the labour market with employment growing by 122k (versus an expected 150k). 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 would be consistent with an ongoing cooling of the labour market perhaps reinforcing the now widely anticipated Fed policy rate cut in September.
Bank of Japan: normal…sort of
In somewhat of a surprise move, the Bank of Japan (BoJ) announced an increase in its policy rate from 0.10 per cent to 0.25 per cent.
It also announced a reduction in the monthly pace of bond buying (i.e. a quantitative tightening) that would roughly halve monthly bond buying to JPY3 trillion from the current JPY6 trillion yen by the first quarter of 2026.
The move cements a will to “normalise” policy after years of a negative interest policy now that inflation is persisting in positive territory. (Although when most of the developed world’s central banks are cutting the policy rate “normal” is somewhat of an ironic moniker.)
BoJ Governor Ueda noted that “we plan to continue raising our policy rate and adjust the degree of monetary accommodation” if economic conditions and inflation move in line with its forecast.
He also noted the weak yen was a factor for policy makers.
With the BoJ in tightening mode and the Fed on the verge of easing it seems reasonable to expect the period of JPY weakness is at an end.
Bank of England: to wait or not to wait
Tonight’s Bank of England (BoE) meeting is a bit of a “lineball” call.
Headline inflation looks satisfactory enough coming at 2.0 per cent. Core inflation, however, remains some distance from the target at 3.5 per cent.
More worryingly, services inflation – which has garnered special attention from the BoE – is running at an elevated 5.7 per cent compared with a BoE projection of 5.1 per cent.
There is an argument for waiting until the meeting on September 19 before contemplating a cut in the policy rate from its current 5.25 per cent, given the patently exhibited inflation proclivities of the UK economy.
Those proclivities include:
- Stronger worker resistance to real wage erosion. These were in evidence in the May wage numbers showing ongoing strong wage growth (5.7 per cent both including bonus and 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.
The forgoing is an argument to exercise patience in contemplating any policy rate cut. I am not convinced the BoE shares that view. The markets are rating the prospect of a policy rate cut at about 60 per cent.
By Stephen Miller, investment strategist
