Stephen Miller

Wage Price Index and RBA minutes: hard to see a September or October hike…but come November?

Last week I noted that the release of the July NAB Monthly Business Survey may have occasioned some amount of hand-wringing at the top end of Martin Place and expressed surprise at an apparent lack of hand-wringing in the markets.

The release this week of wage price index (WPI) data for the June quarter may have allayed any hand-wringing tendency in Martin Place and reinforced some notion in markets that the Reserve Bank of Australia (RBA) was close to end its tightening cycle, if not already there.

That sentiment would have been encouraged not just by the indications of clearly modest wage growth contained in the WPI release but also in a sentence in the RBA minutes that noted that RBA Board members observed a “credible path back to the inflation target with the cash rate staying at its present level.”

If that weren’t enough, ongoing China weakness would also have added to the notion that the RBA is potentially ‘done’.

At the risk of appearing stubborn, I still harbour doubts.

For one thing, there appears to be an emergent tendency for more wage increases to occur at the start of a new financial year (that perhaps aren’t adequately yet captured by backward looking seasonal adjustment techniques). That may mean the September quarter numbers could indicate a substantial acceleration in wage growth as those start-of-financial-year increases take effect alongside the Fair Work Commission’s (FWC) wage review decision, as well as a substantial adjustment for aged care workers.

In that context, I am still not convinced that the RBA forecasts released with the August Statement on Monetary Policy (SoMP) adequately reflect the upside risks to inflation generated by the FWC decision.

That decision is likely to see inflation in Australia exhibit a greater degree of “stickiness” than in other developed countries. This is not something that in my judgement is well understood by the market commentariat.

Sure, there are risks that go the other way, such as indications of weaker activity growth and ongoing weakness in China but those risks are understood by the market commentariat and well reflected in their inflation outlook and in the RBA forecasts.

In that context, I am surprised that the RBA chose to articulate in the minutes that the cash rate might conceivably be already at a cyclical high. Even if it thought that to be the case, the articulation of such a notion might be self-defeating as it risks a perceived diminution in the RBA’s inflation focus among markets and other economic actors (businesses, workers, householders and potential house buyers).

There is also the notion that despite inflation risks, rising recession risks should lead to an indefinite delay in any further policy rate hike(s).

That would be a mistake.

As a self-described “aged” 1970s ruminator – a ‘condition’ with which I am familiar – Niall Ferguson wrote for Bloomberg this week, “I keep having to remind people that the dream of pain-free disinflation was a recurring delusion of the 1970s”.

He was referencing the Federal Reserve (Fed), who in any case seem to have made considerably more progress than the RBA in tackling inflation.

The lesson from the ‘70s is that any delay on the part of a central bank in articulating 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 RBA has been a ‘laggard’ when it comes to tightening and where Australia’s relative inflation performance has been slipping. That is a consequence of the RBA showing a much greater tolerance in terms of the expected timeframe attaching to the return of inflation to target than some other central banks. It could mean that the impact on employment and activity growth may well end up being greater than would otherwise have been necessary had the RBA shown some greater application to inflation containment earlier in the piece.

By contrast, US and Canadian trimmed-mean inflation is running at annual rates of 4.8 per cent and 3.6 per cent respectively (compared with 5.9 per cent in Australia) and the policy rate is much higher in those two countries (a target of 5.25 – 5.5 per cent in the US; a target of 5 per cent in Canada; versus the current 4.1 per cent in Australia). Moreover, the consequences for activity and employment in the US and Canada have been so far at least largely contained.

The return of Australian inflation to somewhere within the target 2-3 per cent band is now forecast by the RBA to be even more elongated than forecast back in May. The RBA project that will not occur until “late 2025” (rather than the June quarter 2025 as forecast back in May).

By contrast to the occasional prevarication exhibited by the RBA, when the Fed and Bank of Canada (BoC) turned their attention to containing inflation, they were resolute in their focus. There is evidence that the approach of the Fed and BoC is close to achieving its aims.

Any failure to ‘lean in’ to the specific pressures generated by the FWC decision might mean that the scale of rate hikes the RBA need visit on the Australian economy to contain inflation will mean any future dislocation in activity growth and employment will be greater.

And I haven’t canvassed the productivity challenges that are confronting the Australia economy. Without a quick turnaround in Australia’s abject productivity performance even modest wage increases will make inflation “stickier”.

The revelation in Tuesday’s minutes that the RBA could conceivably be ‘done’ in tightening monetary policy in the current cycle is not the first time in this cycle that the RBA has (maybe not intentionally) indicated a de-emphasis of inflation focus.

And while I wouldn’t be holding my breath for any near-term rescinding of that sentiment, (with no prospect of a September increase, and very little chance of one in October), come the September quarter price and wage data we might witness a renewal of that hand-wringing as November looms!

UK CPI: no relief for the Bank of England

After perhaps daring to think they might finally be getting on top of inflation, the UK consumer price index (CPI) released overnight suggests that the Bank of England (BoE) still has some work to do.

Headline inflation fell 0.4 per cent in the month driven by lower regulated energy household energy prices, although that was a slightly smaller fall than anticipated. On an annual basis inflation fell to 6.8 per cent from 7.8 per cent reflecting those energy prices and favourable base effects.

On a core basis annual inflation was slightly higher than expected at 6.9 per cent (the same as June). Markets were expecting 6.8 per cent.

These numbers followed extremely strong wage numbers released on Tuesday night (8.2 per cent including bonus; 7.8 per cent ex-bonus) that would have intensified concerns about ongoing “stickiness” in inflation.

The next BoE meeting is not scheduled until 21 September, but it is hard to resist the notion that meeting will see a further increase of at least 25 basis points (bps), taking the policy rate to 5.5 per cent. It is not inconceivable that an increase of 50bps makes the agenda with a terminal rate around 6 per cent viewed as increasingly likely by markets.

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.

Mohamed El-Erian writing for Bloomberg earlier this month makes this same point noting (correctly in my view) that BoE’s job has been made immeasurably more difficult by:

• 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.

However, El-Erian adds (curiously in my view) that it is “perplexing” that the BoE faces such challenges given it was (in his view) the first among its counterparts to acknowledge its mistake in characterising inflation as “transitory” and the first to initiate its rate-hiking cycle to combat high inflation.

I suspect that El-Erian wasn’t paying attention when BoE Governor Bailey in the middle of last year lamented that he felt “helpless” in the face of global price pressures, warning of an “apocalyptic” surge in the cost of food and added for good measure that he has “run out of horsemen” after the pandemic and the war in Ukraine.

Bailey further asserted that price increases were almost exclusively driven by supply shocks that couldn’t have been anticipated and that in any case it was “well established practice to accommodate supply shocks where they’re expected to be transient.” (My emphasis).

If the BoE was first among its peers, then certainly shuffled itself back in the field as it prevaricated in assuming a frontline role in fighting inflation. At least when the Fed and Chair Powell turned their attention to containing inflation, they were resolute in their focus, unlike the BoE. There is evidence that the Fed’s approach is close to achieving its aims. The UK and the BoE are some distance from that point.

The BoE did not seek 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, even if more recently it has hardened up its anti-inflation rhetoric.

The UK inflation circumstance stands in contrast to the progress in the US and Canada where after a stumbling start those central banks embraced an aggressive and unambiguous focus on inflation. There is evidence that the approach of the Fed and Bank of Canada is close to achieving its aims.

The lesson from the ‘70s is that any delay on the part of a central bank in articulating a coherent and firm response to an inflation threat only heightens the risks down of a more damaging macroeconomic dislocation in terms of employment and activity down the track.

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

I fear the RBA may end up in a similar position.

As for the UK, the risk now is that scale of rate hikes the BoE must now visit on the UK economy to contain inflation mean that the extent of any future dislocation in activity growth and employment will be greater than need have been.

RBNZ: no change, but still some risk of a further policy rate hike

As expected, the Reserve Bank of New Zealand (RBNZ) held the policy (official cash) rate (OCR) steady at 5.5 per cent at its meeting yesterday. In so doing, however, the RBNZ noted some risk that it may need to raise the policy rate further to ensure inflation is adequately contained. Such a risk was reflected in new projections from the RBNZ that show the average OCR rising to a peak of 5.59 per cent in mid-2024 before falling to 5.5 per cent by the end of that year.

Prior projections issued in May suggested that the peak in the OCR would be at 5.5 per cent with rate cuts potentially starting in the third quarter of 2024.

At a minimum the RBNZ forecasts imply that the OCR “needs to stay at restrictive levels for the foreseeable future to ensure consumer price inflation returns to the 1-3 per cent target range,” particularly given “a risk that activity and inflation measures do not slow as much as expected.”

The new projections have inflation falling below 3 per cent by the September quarter 2024 (a year ahead of the current RBA projection for Australia).

The projected return of inflation to target reflects projected activity growth of just over 0.1 per cent for this calendar year and 1.6 per cent the following year.

All said and done the decision to “skip” was not a surprise. Indeed, as the RBNZ has itself noted “monetary policy in New Zealand reached a more restrictive level earlier than in many other economies”. In this context, the prospect of a further policy rate hike is best viewed as a risk to a central case that involves the current 5.5 per cent representing a high, even if that 5.5 per cent persists for a considerable period.

By Stephen Miller, investment strategist

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