RBA April preview: keep calm and carry on

Stephen Miller

Coming into next week’s Reserve Bank of Australia (RBA) Board meeting, it is extremely difficult to envisage anything other than a decision to leave the policy rate unchanged at its current level of 4.10 per cent.

RBA Governor, Michele Bullock, portrayed the decision to cut the policy rate at the February meeting as a finely balanced one and sought to frame the bond market’s then expectation of rate cuts as more accelerated than the Bank’s (and presumably the Board’s) view of the expected pace of policy rate reduction. Those comments were an effort to quash the well-known proclivity of financial markets to see policy rate cuts as a necessarily sequential exercise. Since the February RBA Board meeting there has not been a substantial enough augmentation of the economic information set to allow the RBA Board to consider any further policy rate reduction at its April meeting.

Key indicators released since the February meeting include:

• Wednesday’s release of the February monthly consumer price index (CPI) indicator. The annual trimmed-mean number came in at 2.7 per cent which is more or less consistent with the RBA’s February projection.
• The February labour force data which showed a surprising 52.8k decline in employment. That decline, however, seems to reflect supply-side factors associated with the withdrawal of the baby-boomer cohort from the workforce. The unemployment rate was unchanged at 4.1 per cent and probably reflects a more accurate picture of the state of the labour market and is also consistent with the RBA February projection.
• The December quarter wage price index (WPI) which was a little below expectations at 3.2 per cent. However, given abject productivity performance the inflation portents of that number are not quite as positive as they would appear at first glance. 
• March quarter GDP growth of 0.6 per cent or 1.3 per cent over the year. That is still a relatively tepid rate of growth, albeit that the March quarter was slightly better than expected. Again, it was probably in line with RBA projections.
• The Budget is not likely to have had a material impact on the RBA outlook. The tax and spending measures were modest enough and while the Federal Government’s announcement of a six-month extension to electricity rebates will push out the timing of the bounce-back in CPI inflation the RBA will look through this and continue to focus on trimmed-mean inflation. 

All that seems to make the April RBA meeting a bit of a non-event. The May meeting will take place after the Federal Election. At this stage my best guess is a policy rate “hold” at that meeting. That is more a guess rather than a high conviction view. Financial markets are pricing something like a 70 per cent chance of a policy rate cut in May. However, with the Governor confirming that monetary policy aims for the mid-point of the middle of the 2-3 per cent target band it would take a downside surprise on inflation relative to the latest RBA projection for the RBA Board to again cut rates in May. A March quarter trimmed-mean inflation rate of 0.5 per cent (quarter-on-quarter) which translates to an annual rate of 2.7 per cent in the year to March (and would probably see an annual rate of 2.5 per cent by June) would be enough to tip the balance toward a cut in May.

At this stage while such an outcome is plausible, I think it is unlikely. In making that assessment, I am assuming no meaningful deterioration in the labour market. I’m also adopting a (courageously?) optimistic view of the potential disruption to international trade and global activity from the US administration’s tariff plans. So while financial markets are romancing the prospect of some interest rate relief in May, I suspect that it will be some time in the second half of the year before mortgagees can expect any such relief.

In my view, the RBA Governor and Board have done a decent job in fulfilling their responsibilities. As the Governor stated in her parliamentary testimony in February, that is not to say that there hasn’t been any mistakes, but so far the “experiment” in getting inflation back to target without causing substantial dislocation in the labour market (the “narrow path”) seems to be working. 

US: tariff turbulence cruels soft landing hopes

After a short period of apparent calmness tariff fears again appeared to escalate overnight. Risk aversion appeared to be a theme and coincided with a warning from Feds officials that tariffs may be a significant roadblock to inflation falling, and by extension further cuts in the policy rate.  Federal Reserve of St Louis President Alberto Musalem suggested that it’s not clear the impact of tariffs will prove temporary and cautioned that secondary effects could prompt officials to hold rates steady for longer, stating that he  “would be wary of assuming that the impact of tariff increases on inflation will be entirely temporary, or that a full ‘look-through’ strategy will necessarily be appropriate.”

Those comments came after Chicago Fed President Austan Goolsbee stated in a Financial Times interview published yesterday afternoon said that were one to “start seeing market-based long-run inflation expectations start behaving the way these surveys have done in the last two months, I would view that as a major red flag area of concern.” Those warnings came after last week’s Fed meeting which saw the Fed issue economic projections that embodied an incremental swing toward a ‘stagflation-lite’ scenario.

Fed Chair Powell conceded that part of that shift in economic projections was down to the impact of tariffs. Powell, however, noted that the degree of persistence in inflation will depend on whether “transitory” price increases due to tariffs are reflected in inflation expectations. Powell appeared to be optimistic on that front. Musalem and Goolsbee appear less so. Whether the latter is indicative of newly elevated concerns among Fed officials is a key question.

The lesson from the post-pandemic period is that “transitory” elements can persist for longer than policymakers assume and there are key reasons for thinking that the dangers of persistence are currently higher than they have been for some time. For one thing the recent post-pandemic experience will heighten the risk that inflation expectations reman elevated in the wake of price increases motivated by tariffs. For another, the structural currents on inflation are now running in an adverse direction as price pressures are reinforced by the retreat of globalisation of goods markets as governments everywhere (including successive US Administrations) introduce protectionist measures (tariffs) under the specious guise of “industrial policy” and “national champions” or “national security”.

Immigration restrictions and the exit of baby-boomers from the workforce will also add to inflation pressures via higher wage growth. Globalisation of the workforce after the fall of the Berlin Wall as well as migration from developing markets like India and China tended to supress wage growth (and inflation) in the subsequent three decades. That appears to be dissipating. When Donald Trump became US President for a second time the prospects of a US recession in 2025 were small – but not non-trivial. As Larry Summers recently opined, some two months into the President’s term, that risk seems to close to even-money. And were it come to pass, the US authorities are less well-equipped to deal with a recession than they have been for some time.

To get some insight into how quickly things have turned, real GDP through 2023 and 2024 averaged 2.9 per cent and ranged between 1.6 per cent and 4.4 per cent. The current Atlanta Fed GDPNow estimate for current quarter GDP is -1.8 per cent. It won’t take that much to go from there to the popular definition of a recession (two successive negative quarters of GDP growth). In the past quiescent inflation has allowed the Fed to respond quickly to downdrafts in growth and attendant bouts of intense risk aversion. In the current environment, however, “sticky” inflation has diminished the Fed’s flexibility to quickly cut rates, a flexibility that it enjoyed in the two decades or more leading up to the pandemic.  And with a budget deficit approaching 7 per cent of GDP fiscal policy is close to maxed out.

It is not just the tariffs themselves that will do damage (and they most certainly will) but the chaotic manner of the Trump Administration’s execution of that (and other elements of) policy. It has lacked cohesion, rather being marked by chaos, confusion and opacity. The attendant uncertainty is also something that has roiled markets and given the President’s mercurial nature, it is difficult to see that circumstance changing.   Faith that the US economy can stick the soft landing has receded sharply from when President Trump took office.  Trump’s proclivity to meddle with the landing gear may yet cruel any hope of such a landing.