Scott Solomon, Co-Portfolio Manager of the T. Rowe Price Dynamic Global Bond Strategy

A lot can change seemingly overnight in the world of central banks. Looking ahead, we think the second half of 2024 is poised to have a pivotal impact on Australia for the rest of the decade.  

Australia continues to struggle with wealth inequality, which has manifested itself through deteriorating housing affordability. While overall GDP growth shows improvement, per capita growth is negative. For example, under normal conditions a strong housing market translates to strong lending and construction markets. However, the unique nature of this cycle has not seen this transpire. 

This translates to a very difficult job for the RBA as it continues to try and thread the needle of controlling for inflation but also trying to limit excessive pressure on the consumer and households, which are undoubtedly weak. And these impacts are negatively skewed towards younger Australians who on balance own homes at a much lower rate than their parents.

Luckily, inflationary pressure does appear to be waning and we expect inflation will fall within the desired range about a quarter before current RBA estimates. The RBA is unlikely to hike. While we don’t expect Governor Michele Bullock to commit to cuts, it’s unlikely she does much to push back against them. The rest of her global central bank counterparts are dovish – peer pressure is tough to avoid. 

Globally, growth has slowed, and central banks are at the early stages of a cutting cycle. We expect less cuts than what is currently priced as even slight rate adjustments may quickly translate to growth.  We are not in a financial crisis: growth has been driven by government spending instead of increases in credit.  

The concern is that this is only temporary. The problems of wealth inequality in Australia appear structural and are not going away without some sort of changes from government policy. It’s clear the RBA has recognised this and has noted several times they can’t tackle it alone.

With the Federal Election looming next May, voters will face a multitude of decisions. The unfolding events in the remainder of the year will undoubtedly shape the future trajectory of Australia and set the tone for the decade ahead.

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Stephen Miller

Wednesday’s monthly consumer price index (CPI) indicator report added little to the market’s available information set in terms of their expectation regarding the next (almost certainly downward) adjustment in the Reserve Bank of Australia’s (RBA) policy rate.

Favourable base effects relating to electricity prices, including subsidies that took effect from July, saw the headline inflation rate decline to an annual 3.5 per cent. That decline, however, was less than expected. Moreover, domestic (non-tradable) inflation and services inflation remain uncomfortably “sticky” at 4.5 per cent and 4.4 per cent respectively (the former despite those aforementioned favourable subsidy effects).

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 led the market commentariat thinking (rightly in my view) that any reduction would need to wait until 2025.

Market pricing has been more optimistic with current pricing implying a full 25 basis point (bp) cut by year-end.

The last couple of years have seen market pricing of central bank policy rate reductions (both in Australia and elsewhere) prove to be way too optimistic. I think that is the current case that attaches to the RBA and Australian market pricing, albeit in a less egregious fashion than witnessed say in the year and a half leading up to early 2024.

Arguably the best that one can say with regard to the July monthly CPI indicator is that inflation is on a downward path but thus far it is a grudgingly slow process.

And unless there is some 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, any RBA policy rate reduction this year is a remote prospect.

The RBA’s inflation containment task continues to be frustrated by counter-productive government policies despite some tortured political commentary that denies that circumstance.

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.

Government spending would increase aggregate demand by a chunky couple of 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.

Therefore, while there is a plausible (if at this stage improbable) set of circumstances that see a rate cut in 2024, my judgement is to line up behind the assessment of the RBA Governor and Board that any near-term policy rate reduction is unlikely. My sense remains that February 2025 remains the most likely time for the first reduction in the policy rate from its current level, but it could be as late as May 2025.

The improbable circumstance of a rate reduction this year would seem to hinge on a rapid deterioration in the labour market.

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’ significantly beyond that currently forecast by the RBA, then a November policy rate cut may emerge as a reasonable prospect, particularly if the September quarter CPI print is in line with (or better than) the recently issued RBA forecast.

That notion may be fuelled should the Federal Reserve (Fed) cut its policy rate by 50bps when it meets in September (something I regard as unlikely) and the Australian dollar (AUD) appreciates sharply leading to a tightening of financial conditions.

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.

However, in the absence of an unlikely trifecta of “acceptable” inflation outcomes (in line with RBA forecasts or better), a rapid and excessive dislocation in the labour market, and an aggressive Fed policy rate cut that results in a sharp appreciation of the AUD, a Melbourne Cup Day policy rate cut remains a long shot.

Aside: RBA Deputy Governor Hauser seems to have copped a fair amount of criticism for his recent Beware of False Prophets address. Perhaps someone should have warned the Deputy Governor of the Australian “tall poppy syndrome” penchant.

Some might attribute that national characteristic to the country’s longstanding egalitarian tradition (if indeed that does exist). Others might put it down to a collective national insecurity about their own place in the world and its importance (or lack thereof).

Whatever it is, I think the criticism of Hauser was off the mark. My view is that most commentators missed the fundamental point he was making. As AFR economics editor, John Kehoe wrote, this was that central banks need to understand the huge limitations on their knowledge of the economy and more than that be open about those limitations and make sure markets understand them.

Financial markets crave guidance from central banks. In their craving for such guidance, however, there is often a lack appreciation of the limitations on central banks in the provision of such guidance and (as I’m sure former RBA Governor Philip Lowe would argue) an ignorance of any conditionality that attaches to central bank commentary and guidance. (In saying that I’m not excusing Lowe’s now (in)famous guidance regarding the timing of policy rate rises. He himself should have given way more emphasis on the conditionality around that guidance.)

To invoke that famous central banking philosopher, former US Defence Secretary Donald Rumsfeld, there are ‘known unknowns’ (particularly manifest in the post-pandemic period) and omnipresent ‘unknown unknowns’.

RBA Governor Bullock has been clear on this as exemplified by the ‘not ruling anything in or out’ mantra attaching to likely future moves in the policy rate.

Hauser’s speech was an attempt to make this clear and so avoid the sort of imbroglio that followed Lowe’s now (in)famous guidance.

Powell at Jackson Hole: the time has come the Walrus said…

US Fed Chair Powell’s address at the Kansas City Fed’s Jackson Hole Symposium confirmed one of the Fed’s worst kept secrets: that the Fed will cut the policy rate at its September 17-18 FOMC meeting.

Powell’s language was unequivocal, asserting ‘the time has come for policy to adjust’.

Powell’s address implied (not without reason) that it is “mission accomplished” on inflation and that the Fed is focused on the other element of their dual mandate; viz, minimising any deviation from full employment. Powell stated that the Fed does ‘not seek or welcome further labour market cooling’ and that the Fed would ‘do everything we can to support a strong labour market.’

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 Fed’s favoured core personal consumption expenditures (PCE) measure was running at a 3-month annualised pace of 2.3 per cent in June. It is likely to come in around (or even a tad lower) than 2.0 per cent when the July numbers are released on Friday.

The July non-farm payrolls report appeared to show a rapidly cooling labour market so much so 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. But it will probably need the August payrolls data released on 6 September to show a continuation of the weakness evident in the July report to elicit such a cut.

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, a surge of new labour force entrants increasing unemployment and the absence of any dramatic weakening – as opposed to orderly “cooling” – evident in other labour indicators). On that basis one would expect some bounceback when the August report is released on 6 September. 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, as I tentatively expect, the August payrolls do show some bounceback, I think that will be sufficient for him to stay with that script.

By Stephen Miller, investment strategist

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Stephen Miller

At the time of the release of the September quarter consumer price index (CPI), I suggested that an annual increase of 5.2 per cent in the annual trimmed-mean (TM) inflation rate made a policy rate rise from the Reserve Bank of Australia (RBA) on Tuesday 7 November a near certainty.

The October RBA Board meeting minutes revealed that the Board “has a low tolerance for a slower return of inflation to target than currently expected.”

Given that the RBA forecast was around 4.8 per cent, it would be extremely difficult to reconcile that “low tolerance” with the absence of any policy rate hike.

RBA Governor Michele Bullock has since stated that “the Board will not hesitate to raise the cash rate further if there is a material upward revision to the outlook for inflation.” Despite Treasurer Chalmers protestations to the contrary, the September quarter CPI revealed that “material” benchmark has been more than met.

Chalmers intervention may have the perverse effect of solidifying the prospect of a policy rate hike. Were the Board to eschew such a hike the optics around their independence would look compromised.

Not only is a policy rate hike entirely appropriate in the wake of the exhaustion of the RBA’s hitherto (too) high (a) tolerance for an elongated return of inflation to the target, but it is also given some extra urgency by some gathering inflation storm clouds on the horizon.

There is a widespread misnomer that inflation is simply down to external price shocks or petroleum prices. (Treasurer Chalmers sometimes appears to labour under the same misnomer). It is not! It is much broader than that. It is to avoid confusing large relative price movements with generalised inflation that the RBA focuses (properly) on the “trimmed mean” measure.

There is a similarly widespread misnomer that the policy rate is “high”. It is not! Prior to 2008, the policy rate had never been as low as it is now. The period since was the exception, spawned as it was by first the Financial Crisis and then the Pandemic. It is now clear that the historically high level of monetary accommodation in the wake of the Pandemic went on for way too long and that central banks everywhere have been way too tardy in its withdrawal. That is a key reason behind the current inflation and its persistence.

Central bankers around the world have remarked on the “stickiness” of service price inflation. The globalisation of labour supply (after the fall of the Berlin Wall and the “export” of labour from large emerging market economies such as China and India) is abating; globalisation of goods markets is in retreat as governments everywhere introduce protectionist measures under the guise of “industrial policy” and “national champions”; domestic regulation of markets is increasing in scope (leading to upward price pressures); and baby boomer workforce participation is declining (limiting labour supply and lifting wages).

There are some other purely domestically driven troublesome inflation portents. Recent changes in the regulatory environment in Australia, particularly in relation to the wage-setting and the industrial relations framework, potentially exacerbate an already stubborn inflation problem. By weakening the link between productivity and nominal and real wage growth those measures run the risk of entrenching higher inflation in Australia compared to elsewhere in particular.

The Governor noted in her Statement following the RBA October Board meeting that “wages growth … is still consistent with the inflation target, provided that productivity growth picks up”. (My emphasis). That increasingly looks like a big “if”!

Wage increases are digestible in times of robust productivity growth. However, productivity growth in Australia is abjectly poor and even with relatively modest wage growth, unit labour cost growth (the most relevant labour cost gauge for inflation) is at over 7 per cent per annum.

The interplay between productivity and wage growth are domestic developments upon which the RBA will cast a keen eye.

In the meantime, expect the RBA to reveal hawk talons on 7 November.

They may be on show for some time.

By Stephen Miller, investment strategist

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Stephen Miller

In refreshing contrast to her predecessors and peers, new Reserve Bank of Australia (RBA) Governor, Michele Bullock, has an endearingly plain-spoken and direct approach. 

That was on display this week.

In the first instance there was a very strong signal from the minutes of the October RBA Board meeting that should the September quarter consumer price index (CPI) to be released next Wednesday show inflation to be tracking above the RBA August Statement on Monetary Policy (SoMP) forecast, then the RBA Board will choose to raise the policy rate at its November 7^th Board meeting.

Those minutes revealed that the Board “has a low tolerance for a slower return of inflation to target than currently expected,” which given asymmetric upside risks to the current RBA forecast is suggestive of a strong potential for a November policy rate increase.

In case markets missed the message, Governor Bullock reinforced that message in her comments to the Australian Financial Security Authority (AFSA) Summit on Wednesday when she noted that there were “a few things that are suggestive that it’s going to be difficult to get inflation down,” and expressed some anxiety regarding “pretty sticky” services inflation.

Those comments are entirely appropriate for a central bank that still faces some challenges when it comes to inflation containment.

As Governor Bullock notes, the “stickiness” attaching to services inflation (which in the main reflects wage growth) is not unique to Australia.

However, and while the Governor refrained from making this point, it is arguable that recent changes in the regulatory environment in Australia, particularly in relation to the wage-setting and the industrial relations framework, potentially exacerbate that problem because in large measure they weaken the link between productivity improvements and real and nominal wage growth.

The September quarter CPI (and perhaps the December quarter too) may reflect some consequence of the Fair Work Commission (FWC) wage review decision announced in early June, which likely intensified inflation pressures. Such wage increases are digestible in times of robust productivity growth. However, productivity growth in Australia is abjectly poor and even with relatively modest wage growth, unit labour cost growth (the most relevant labour cost gauge for inflation) is at over 7 per cent per annum. 

As the Governor noted in her Statement following the RBA October Board meeting, “wages growth … is still consistent with the inflation target, provided that productivity growth picks up”. (My emphasis). That increasingly looks like a big “if”.

She also noted that the “recent data are consistent with inflation returning to the 2–3 per cent target range over the forecast period.” (My emphasis)

However, judging from her interventions this week, the Governor may now feel that the backward focus on recent data does nothing to assuage nascent anxieties that inflation in Australia will be revealed as “sticky” enough to force the RBA’s hand in November.  

The recent September NAB Monthly Business Survey revealed some acceleration in wages and prices in the quarter, although to be fair that acceleration appeared to wane as the quarter progressed. The latter observation notwithstanding, the survey remains consistent with ongoing elevated (“sticky”) inflation. 

Were those trends to presage a similar reacceleration of wage and price pressures in the more lagged official Australian Bureau of Statistics (ABS), particularly next week’s September quarter CPI released on October 25^th,  then a policy rate increase will be on the agenda for the next meeting on November 7th.

NAB economists issued a forecast quarter-on-quarter increase for the September quarter trimmed-mean CPI of 1.1 per cent (circa 5 per cent plus annual), above the RBA’s 0.9 per cent. In my view, on the basis of the price and wage numbers in the NAB Monthly Business Survey, there may even be upside risk to the NAB economists’ forecast.

In that context, RBA forecasts released with the August Statement on Monetary Policy (SoMP) may not adequately reflect the upside risks to inflation. 

An annual September quarter trimmed mean inflation outcome of 5 per cent or above will inexorably put pressure on the RBA Board for a November policy rate hike.

Governor Bullock’s interventions this week suggests that the RBA is exercising its hawk’s talons. 

The Fed: the talons remain extended! 

Last week’s elevated core inflation result for September suggested that a further increase in the policy rate remains on the agenda for future meetings of the Federal Reserve Federal Open Market Committee (FOMC). 

In my view, this week’s September retail sales release all but confirmed that.

Moreover, I expect that to be the key takeaway when Fed Chair Powell addresses the Economic Club of New York at midday Thursday (3am Friday morning AEDT). 

While it is conceivable that the march higher in bond yields may see the Fed keep policy rate hikes in abeyance, Chair Powell will seek to give markets the message that further hikes remain an option and reinforce the “high indefinitely” mantra that it has attached to its recent commentary on the policy rate. That would imply that current Fed thinking does not contemplate any policy rate cuts until at least the second half of 2024. 

So for the time being at least the policy rate is at best at a “plateau” rather than a “peak”.

Chair Powell’s comments are likely a device to forestall a further easing in financial conditions. The US bond market has consistently under-estimated how high the Fed would take the policy rate and how far the Fed is from contemplating any cut in the policy rate. Markets have more recently tempered their difference of view with the Fed, and given ongoing resilience in activity data, Chair Powell will be careful not to excite any exuberance. Certainly, to the extent that bond yields remain at levels not seen since 2007 means that the Fed has been successful in this endeavour.

Chair Powell would not wish those hard-won endeavours to be compromised.

The talons remain extended

BoE and UK CPI: lost talons (or perhaps a “dove’s breakfast”)! 

In the wake of some evidence of moderating (albeit still highly elevated) inflation numbers in August, the Bank of England (BoE) Monetary Policy Committee decided by a narrow 5-4 margin to eschew an increase in the policy rate at its September 21^st meeting, maintaining the base rate at 5.25 per cent. 

That decision surprised some (including this writer) who had thought the BoE might have learnt some lessons from the appearance of prevaricating in the face of the inflation challenge it was facing in 2022. 

The September consumer price index released overnight go to emphasise that the BoE still has a fight on its hands and that any extended prevarication on its part in assuming a frontline role in the fight against inflation risks a more substantial macroeconomic dislocation down the track. As the self-described “aged” 1970s ruminator, Niall Ferguson, wrote for Bloomberg some weeks ago he “keeps having to remind people that the dream of pain-free disinflation was a recurring delusion of the 1970s”.  In other words, the lesson from the 1970s is that any delay on the part of a central bank in enacting a coherent and firm response to an inflation threat only heightens the risks down of a more damaging macroeconomic dislocation in terms of activity and employment down the track.

The BoE is running that risk.

The September release showed headline inflation unchanged at 6.7 per cent in September (versus 6.6 per cent expected).

On a core basis annual inflation was slightly higher than expected at 6.1 per cent versus 6.0 per cent expected and 6.2 per cent in August. 

These numbers followed elevated wage growth numbers released on Tuesday night (8.1 per cent including bonus; 7.8 per cent ex-bonus). Such numbers should only intensify concerns about ongoing “stickiness” in inflation.

The next BoE meeting is not scheduled until 2nd November. Markets were pricing only a 30 per cent chance of an increase in the policy rate to 5.5 per cent. That may reflect an assessment that the BoE has “lost its talons” and despite the eminently prosecutable case for a further policy rate hike, the BoE will decline to do so. I would have thought given the surprising nature of the September decision and the closeness of the vote in September that the chances should be much higher than 30 per cent. 

At a minimum a further hike is justified on “insurance” (against inflation) grounds.

The BoE is not solely responsible for the awkward circumstance in which the UK economy finds itself. The mismanagement of Brexit occasioned by a distracted Johnson Government and the turmoil wrought by the fleeting Truss Government indisputably played major roles, including adding unnecessary inflation pressure. 

In addition, the BoE’s job is arguably more difficult than in most other developed countries, at least with respect to the inherent inflation proclivities peculiar to the UK. These reflect a number of factors: 

• Stronger resistance to further real wage erosion among segments of the labour force, evidenced by the combination of the highest nominal wage growth and widespread industrial action.
• Disruptions in external trading relations post-Brexit that slow supply chains and make them less cost-effective.
• A lower degree of internal economic flexibility contributing to longstanding productivity challenges.
• Limited government support for supply-side enhancement in comparison with the efforts of the US and, to a lesser extent, the Eurozone.

In that context it is no surprise that the UK has among the highest inflation readings in the developed world, and certainly the highest in the G7. 

But that should have escalated the urgency of the BoE in embracing a frontline role in containing inflation.

Yet, the BoE has not sought to avail itself of opportunities to more ostensibly ‘lean in’ to inflation pressures generated by poorly designed Government policies. In that sense it is complicit in the creation of the challenging circumstances created by the stubborn UK inflation. 

That is the nature of costs associated with the BoE prevarication. 

The risk now is that scale of rate hikes the BoE must visit on the UK economy to contain inflation will only grow the longer it prevaricates and that, accordingly, the extent of any future dislocation in activity growth and employment will be much greater than it need have been. 

The BoE needs to find its talons or the UK economy will end up looking like a “dove’s breakfast”!

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