Stephen Miller
As expected, the RBA kept the policy rate unchanged at 4.35 per cent when it met earlier in the week. Furthermore, despite a plethora of disingenuous political commentary around monetary policy recently, RBA Governor, Michele Bullock gave a clear outline of the rationale behind the RBA’s stance while acknowledging that the RBA is alert to the risks around its central case forecasts.
Put very simply, in the RBA view demand is still running ahead of supply, making for “sticky” inflation and until the Board is confident that state of excess demand will be resolved, current policy settings will remain.
And while the Governor acknowledged that the September RBA Board meeting did not explicitly discuss a policy rate hike, she was careful to downplay the prospect of any near-term policy rate cut.
In my view, the Governor struck the right tone in her press conference.
Where the RBA has differed from other developed country central banks, is that it has shown a reluctance to raise rates as far and as fast.
The consequence has been relatively lower policy interest rates than most other developed countries, but relatively better labour market outcomes.
The downside has been relatively “stickier inflation”.
And what that means is that in Australia policy rate adjustments on the downside will lag those in other developed countries.
Economic developments since the last meeting have by and large vindicated the RBA “experiment”.
That is a point that is lost by the at times ill-informed, even febrile, commentary from current and former politicians.
As it has in the past, the RBA Board acknowledged the risk that the ‘pickup [in household spending] is slower than expected, resulting in continued subdued output growth and a sharper deterioration in the labour market.’
There is, as yet no evidence of that ‘sharper deterioration in the labour market’.
And while the August monthly CPI indicator showed a headline inflation rate at 2.7 per cent (within the 2-3 per cent target band), it does not represent, in the Board parlance, a ‘sustainable’ return of inflation to target.
The apparent disinflation reflects electricity subsidies which will ultimately unwind. That measure therefore overstates the sequential progress on inflation and will not materially alter the RBA’s stance.
Therefore, unless there is either a wholly unanticipated, and at this stage unlikely deceleration in inflation, that is at a pace greater than revealed by the most recently issued RBA forecasts, or any unlikely and significant deterioration in the labour market between now and the November meeting, any RBA policy rate reduction this year is a remote prospect.
In an interesting aside the Governor alluded to less-than-optimal supply chain responses and attendant abject productivity growth as being in part responsible for excess demand and inflation. Absent a recessionary lurch in the global economy and / or a “sharper deterioration” in the labour market, it remains difficult to see a policy rate reduction before February 2025.
Coming up: US August PCE price index
US interest rate markets are romancing the notion of a further 50 bp reduction when the Fed next meets on November 6-7.
That comes despite some reluctance from Fed Chair Powell to embrace such guidance at his recent press conference following the Fed decision to cut the policy rate in September. Having said that he also did not rule it out.
Fridays release of the August core PCE price index will be important in gauging the potential for a further 50bp cut.
At this stage it is difficult to imagine Friday’s release being anything other than benign enough to allow a further policy rate cut should the labour market continue to show signs of cooling.
To all intents and purposes and purposes the Fed has returned inflation close enough to the target of 2 per cent. Consensus expectations for the Friday’s number is for a monthly increase of 0.2 per cent. That would put the 3-month annualised number at 2.1 per cent and an annual increase of 2.7 per cent.
The monthly rate of increase implied by the Fed’s median core PCE forecast implies monthly increases of around 0.15 per cent. Such an increase for August would see the 3-month annualised rate of inflation remain below 2 per cent between now and year-end .
It seems clear now that the Fed is more focused on the labour market side of its dual mandate.
In that context, and in the absence of any unlikely upside surprise in the August number, the balance of probabilities between a 25bp or a 50bp reduction at the November meeting probably depends more on labour market developments.
Powell cast the decision to opt for the higher 50bp quantum of reduction in September as reflecting that the inflation risks have diminished while labour market conditions are at some risk of deterioration.
Nevertheless, Powell was careful to characterise the labour market as still fundamentally healthy preferring to cast the Fed decision as preserving a strong labour market rather than reacting to one that was in a state of weakness. That might be designed to prevent markets anticipating “too much” easing.
In that context, the personal income and spending data that accompany the release are also important given that the September quarter looks to have exhibited reasonably strong growth footing thus far with the Atlanta Fed GDP estimate for Q3 running at 2.9 per cent. Such an environment implies little likelihood of any significant deterioration in the labour market. This makes me lean (without any great deal of conviction) to a 25 bp cut as the most likely outcome on 7 November.
Clearly, however, all eyes will be on the non-farm payrolls release on Friday 4 October in order to gauge the veracity of that conjecture.
Coming up: Preliminary France and Spain CPI data
Preliminary September CPI data for both France and Spain are released on Friday evening.
With those results likely to presage Eurozone inflation (harmonised index of consumer prices or HICP basis) to be under 2 per cent when that number is released on Tuesday 1 October markets may well be tempted to contemplate the possibility of a 50bp policy rate reduction from the ECB when it meets on October 17th, particularly in the wake of the Fed’s decision to cut 50bps.
While a reading under 2 per cent might reflect temporary factors, it seems clear that Eurozone inflation is at or close to the target while ongoing tepid activity growth garners more attention.
By Stephen Miller, investment strategist
