Stephen Miller
Last night’s US July consumer price index report makes a policy rate cut at the US Federal Reserve’s (the Fed’s) September 17-18 Federal Open Market Committee (FOMC) meeting a virtual certainty.
Coming on the heels of a better than expected Producer Price Index (PPI) report on Tuesday evening, which augur well for continued positive reads in the Fed’s favoured inflation measure – the core private consumption expenditure (PCE) price index – the only debate seems to be whether the Fed chooses to kick-off with a 25 basis point (bp) policy rate cut or a 50 bp cut.
The arguments for the higher quantum of cut are that to all intents and purposes the Fed has achieved its inflation objectives. Measures of the inflation “pulse” show the Fed has achieved (or bettered) its 2 per cent target.
The 3-month annualised core CPI is now running at 1.6 per cent, the lowest such rate since February 2021 when inflation was believed to be in a state of virtual semi-permanent abeyance (absent “transitory pandemic and conflict related pressures). The Fed’s favoured core PCE measure was running at a three-month annualised pace of 2.3 per cent in June. It is likely to come in around 2.0 per cent when the July numbers are released at the end of this month.
Fed Chair Powell and other Fed FOMC members have recently highlighted that their focus is shifting toward the other element of their dual mandate; viz, minimising any deviation from full employment.
The July non-farm payrolls report appeared to show a rapidly cooling labour market to the extent that some of the market commentariat thought them a harbinger of an imminent recession.
With the inflation “pulse” at less than 2 per cent and with the labour market (according to some) flashing recession signals, and with policy described by Fed Chair Powell as being in “restrictive” territory, the way is certainly open for the Fed to cut 50bps.
However, even leaving aside the market tendency over the last few years to “cry wolf” on recession, there are reasons to think that the July figures overstated the extent of weakness in the labour market (associated with temporary lay-offs depressing the employment count and a surge of new labour force entrants increasing unemployment). On that basis one would expect some bounceback when the August report is released on September 6. Were such a bounceback to eventuate, the Fed might seek to implement a 25bp cut in September and express a disposition, contingent on the data, to follow-up with similar cuts in November and December.
At this point, and not with a great level of conviction, I think the (latter) more cautious approach more likely.
At his press conference following the last meeting (but before the July payrolls release) Powell stated that a 50 bp cut was “not something we’re thinking about right now.” If the July payrolls do show some bounceback, I think that will be sufficient for him to stay with that script.
Coming up: July labour force
Today’s July labour force data are an important data point before the next RBA Board meeting on September 23-24.
RBA Governor Michele Bullock cast a hawkish hue over the most recent RBA Board decision to leave the policy rate unchanged at 4.35 per cent at its August meeting. In particular, her affirmation that the Board considered a policy rate rise (but not a cut) combined with an assessment that any near-term reduction in the policy rate was unlikely had markets believing that the first opportunity for a policy rate reduction will not be until February 2025.
While there is a plausible (if at this stage improbable) set of circumstances that see a rate cut in 2024, the Governor’s assessment seems appropriate enough.
The Board noted in its Statement following the August meeting that “momentum in economic activity has been weak…[a]nd 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.”
Were the monthly labour force releases between now and the meeting in November to reveal a “noticeable deterioration in the labour market” beyond that currently forecast by the RBA then certainly a November policy rate cut is a reasonable prospect, particularly if the September quarter CPI print is in line (or better than) the recently issued RBA forecast.
This week’s wage data and the price indicators from the NAB Monthly Business Survey shouldn’t heighten any existing concerns about inflation. Nor should they allay any fears about the current apparent “stickiness” of inflation. As Governor Bullock has emphasised progress on productivity is as important as what the wage data might reveal.
But importantly, the RBA has a dual mandate that relates to minimizing unemployment as well as inflation containment. My sense is that the Governor and the Board take that duality extremely seriously.
Therefore, given “acceptable” inflation outcomes (in line with RBA forecasts or better) were the monthly labour force data to reveal excessive dislocation in the labour market a November policy rate cut could be on the table.
Consensus expectations are for an increase in employment around 20k and for the unemployment rate to remain unchanged at 4.1 per cent.
In my view, it would take an outcome significantly worse than the consensus for the RBA to start thinking about a policy rate reduction. That would be a significant fall in employment (greater than 25k) and an unemployment rate at 4.3 per cent or greater.
RBNZ joins the rate cut reduction party
In what markets appeared to assess prior to the event as a “lineball” call, at its meeting on Wednesday the RBNZ chose to cut the policy rate (official cash rate or OCR) from 5.5 per cent to 5.25 per cent and foreshadowed more cuts to come.
In announcing the decision, the RBNZ assessed that New Zealand’s consumer price inflation appeared to be “returning to within the Monetary Policy Committee’s 1 to 3 percent target band.”
It also noted that “[s]urveyed inflation expectations, firms’ pricing behaviour, headline inflation, and a variety of core inflation measures were also “moving consistent with low and stable inflation.”
Meanwhile “[e]conomic growth remains below trend.”
Partially reflecting a greater inflation proclivity, the RBNZ had been one of the more aggressive central banks in hiking the policy rate.
However, given weakness in economic activity growth, clearly declining inflation and a likely further disinflationary pulse reflecting lags from an extended period of restrictive monetary conditions, the RBNZ thought it prudent to cut at this meeting.
Furthermore, given the current state of the New Zealand economy and the still relatively high policy rate, the RBNZ gave a strong indication that the move at this meeting likely constitutes a platform for further successive policy rate reductions at future meetings. In updated projections of the policy rate the RBNZ now see the OCR below 5 per cent by the end of the year and below 4.5 per cent by the middle of 2025. Market projections have an even more accelerated pace of reduction.
UK CPI and the Bank of England: Down down?
In the wake of last night’s better than expected July UK CPI figures, a further cut in the policy rate is now more likely than not when the Bank’s Monetary Policy Committee next meets on September 19th .
Headline inflation rose to 2.2 per cent from 2.0 per cent in June and was slightly better than the 2.3 per cent expected. Core inflation fell to 3.3 per cent from 3.5 per cent in June and was similarly slightly better than the 3.4 per cent expected.
Services inflation – which has garnered special attention from the BoE – fell sharply to 5.2 per cent from 5.7 per cent in June. That movement would give some encouragement to the BoE that inflation is within the realms of being sustainably contained, although somewhat higher than anticipated wage growth may temper that optimism somewhat.
There is an argument that given the patently exhibited inflation proclivities of the UK economy for waiting until the meeting on November 7 before contemplating a cut in the policy rate.
With the unemployment rate remarkably resilient at 4.2 per cent too rapid an easing might see unduly “sticky” inflation potentially occasioning a greater and more disruptive dislocation in employment and activity down the track. However, at this stage, I suspect the BoE is more inclined to view the labour market as a little more fragile than the official figures would have it and are accordingly inclined to see some benefit of looking through what it regards as temporarily elevated services inflation and taking the policy rate lower in September.
By Stephen Miller, investment strategist
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