Stephen Miller

US August inflation surprised on the upside. ‘Headline’ inflation came in at 8.3 per cent (versus 8.1 per cent expected) while ‘core’ inflation registered 6.3 per cent (versus 6.1 per cent expected). Rather than herald the much vaunted peak in inflation, last night’s release suggests core inflation has plateaued at elevated levels.

Disconcertingly, the strength in core inflation was led by the service sector where inflation is typically led by wage inflation. In some sense that should not surprise given the ongoing tightness in the US labour market.

Last night’s release reaffirms the rationale behind the hawkish tack from the Fed in the face of episodic market optimism of a “pivot” to a less aggressive stance.

That episodic optimism on the part of US financial markets can perhaps be better cast as episodic complacency, and it may well give pause to those in domestic markets looking for an imminent “pivot” from the RBA to lower policy rate increments.

What remains troubling and what will continue to focus the minds of the Fed and financial markets, if the latter are able to shake off a proclivity toward complacency, is the continued strong momentum in ‘underlying’ measures of inflation.

Measures of the ‘underlying’ inflation pulse continue to show extraordinary momentum and no meaningful evidence of retreat from historically high levels. On a 3-month annualised basis, the Cleveland Fed measure of median and trimmed-mean inflation are running at 8.3 per cent and 7.7 per cent respectively.

Such readings should put paid to the notion that inflation reflects just a few outsized price increases in selected commodities or ongoing supply chain blockages. Rather, that sort of inflation pulse is indicative of an inflation inertia (last seen in the late 70s / early 80s) that may yet prove a lot more difficult to arrest than markets are currently contemplating.

Of course, for the Fed the key issue is not whether inflation has peaked (elusive as that peak has proven to be) but how quickly it gets back to something below 3 per cent.

Last night’s release cements the likelihood of a 75 basis point increment in the policy rate when the Fed’s FOMC meets next week.

Markets are now pricing a peak policy rate of around 4.30 per cent in the second quarter of 2023 with easing thereafter to under 4.00 per cent by end-2023.

With a peak policy rate above 4 per cent, market pricing now looks more in line with the Fed’s trajectory.

It may be that bond yields still have a little upside, and in my view may well end up close to a “4 handle”.

RBA: market hares running toward the inflation hounds. Imminent step-down in policy rate increment unlikely as domestic inflation remains “sticky”

RBA Governor Philip Lowe got the market hares running with last week’s speech to the Anika Foundation.

As part of an ongoing obsession with spotting a RBA pivot, the market commentariat trumpeted that the RBA was about to imminently reduce the monthly policy rate increment to 25 basis points. This after a reference to a couple of unremarkable notions that monetary policy operates with a lag and that the case for a slower pace of increase in interest rates becomes stronger as the level of the cash rate rises.

Investors should be wary of the commentariat punditry. After all, the pivot obsession has in the past led the commentariat to predict “eight of the last two pivots”!

It may be that markets have missed the key messages in Lowe’s address. That message is that RBA Board wishes to give itself maximum optionality when it comes to determining the size and timing of future policy rate increases and that incoming data will be the most important determinant of the future policy rate trajectory.  Hence Lowe’s carefully worded counsel that the RBA was “not on a pre-set path” when it came to future policy rate increments.

Given the current elevated level of uncertainty that attaches to both the domestic and global economic outlooks, that seems entirely appropriate.

Of course, that is not necessarily inconsistent with a step-down in monthly policy rate increases but nor does it any way make that eventuality any nearer than it might have appeared prior to the Lowe address.

After last year’s ill-fated guidance that the conditions for a policy rate increase “will not be met before 2024,” the last thing the Governor needs to do now is to appear to pre-commit to a policy path that is subject to the aforementioned uncertainty.

Some commentators have warned that given the lags in monetary policy there is a risk that the RBA may overdo it and plunge the economy into recession.

That is a risk, but so is a premature declaration of victory over the inflation threat.

It might be that too soon a reduction in the policy rate increment also runs the risk of letting the inflation genie run amok.

On that front, it is clear that higher frequency price and wage data continue to exhibit considerable momentum.

That what Lowe described as the “scourge” of inflation is a clear and present danger.

Tuesday’s release of the NAB Monthly Business Survey continued to exhibit troubling inflation portents for the September quarter and beyond.

Final product retail prices in the August survey increased at a quarterly rate of 3.3 per cent; the same record rate as was recorded in July.

Such momentum indicates a danger of the emergence of the sort of inflation inertia that was last experienced on a global scale in the late 70s / early 80s. (It lasted a little longer in Australia.)

Moreover, it is suggestive of some upside risk to the most recent RBA trimmed-mean inflation forecast, issued just over a month ago, of a 6 per cent increase over the year to the December quarter 2022.

Investors should therefore regard any notion of a near-term RBA pivot with the maximum of caution.

It might well turn out to be yet another case of the market hares running toward the inflation hounds.

Another UK CPI: Surprises on the downside at “only” 9.9 per cent!

Finally, some good news on UK CPI inflation: it was “only” 9.9 per cent (versus an expected 40-year high of 10.2 per cent) and down from the 10.1 per cent recorded for July. The core measure came in as expected at 6.3 per cent, up from 6.2 per cent in June.

The narrative around high developed country inflation is well known – large increases in selected commodity prices and supply chain bottlenecks morphing into a more broad-based inflation, partially reflecting earlier central bank laxity.

The “good” August result notwithstanding, the Bank of England has been a conspicuous offender when it comes to central bank laxity. Brexit may be a contributor at the margin, largely reflecting an unwillingness on the part of the government to address some of the supply chain issues and labour shortage issues that have arisen as a consequence.

The Bank of England’s complicity result from its inability to articulate and execute a coherent strategy for dealing with the inflation.

Moreover, moves by the incoming Truss Government to cap household energy bills (funded by government borrowing) are likely to do little to curb the fundamental underlying inflation pressures.

The elevated ‘core’ reading is indicative of an inconvenient truth facing all developed country central banks; viz, that current inflation reflects more than just a few outsized price increases in selected commodities or ongoing supply chain blockages. Rather, it is indicative of an inflation inertia (last seen in the late 70s / early 80s) that may yet prove a lot more difficult to arrest than markets are currently contemplating.

The essential primary task of a developed country central bank is to contain inflation. The Bank of England’s failure in this is more egregious than nearly all of its developed country counterparts (with the possible exception of the European Central Bank).

Like nearly every other developed country central bank, the Bank of England was tardy in recognising just how great a challenge inflation would prove for monetary policy. However, in my view not only was it lax in recognising the problem, it also has been lax (compared to other central banks) in attempting to rectify the consequences of its earlier policy missteps.

That some commentators lauded the Bank of England’s “analytical directness and intellectual honesty” when they “fearlessly” forecast a peak of 13 per cent in inflation this calendar year is a surprise to me.

Sure, the Bank of England may deserve marks for “fearless” forecasting – or “honesty” – but in my view it scores woefully (both relative to other central banks and outright) on the competence front.

Many central banks (the Federal Reserve, the Bank of Canada, the Reserve Bank of New Zealand, the Reserve Bank of Australia) appear to have learned (admittedly late in the piece) the lessons from 70s style inflation: viz, that any delay in articulating a coherent and firm response to an inflation threat only heightens the risks of more substantial macroeconomic dislocation down the track. It is not an easy task charting a course between vanquishing inflation without tipping the economy into recession. History is not replete with central banks executing that task successfully. However, the aforementioned at least gives themselves a shot at “second-best” outcomes.

Up until its last meeting on 4 August when it (finally and a little grudgingly) delivered a 50 basis point increment in the policy rate to 1.75 per cent, the Bank of England’s response, was to partly default to a more highly risky approach of letting a squeeze on real incomes become the “cure” for a diminishing of inflation. That involves a more elongated and painful approach than an expeditious shifting of policy rates to neutral levels and beyond. In so doing it (along with the European Central Bank) appears to have unwittingly opted for a “nth” best strategy. That approach risks the worst of both worlds – a vicious and lasting stagflationary environment (albeit one that is “honestly” forecast).

Moreover, Governor Bailey frequently gave the impression that he was unconvinced that the Bank of England had a frontline role to play in containing inflation.

The Bank of England has shifted to a more aggressive stance. Markets are currently contemplating a policy increment of either 50 basis points or 75 basis points when the Bank of England holds its (delayed) meeting next week.

There is a suggestion that the Government measures to cap energy bills give the Bank of England cover to only go 50 basis points. For the reasons outlined above, I think such an approach is flawed and prudence dictates the desirability of the higher increment. As mentioned, to do otherwise only heightens the risks of more substantial macroeconomic dislocation down the track.

Coming up: Australian July labour force

The Australian August labour force data to be released today are expected to reinforce the notion of likely ongoing tightness in labour market conditions. July’s release revealed the unemployment rate at a 48 year low of 3.4 per cent (even if employment fell some 41k). This followed June’s blockbuster numbers which showed an employment increase of 88.4k. The consensus expectations reported by Bloomberg are for an increase in employment of circa 35k and an unchanged unemployment rate at the 48 year low of 3.4 per cent.

That volatility exhibited in the June and July releases are indicative of a little statistical noise so there is some risk of a surprise print in July.

Regardless, it is difficult to argue against the proposition that labour markets are tight. Anecdotes of this abound and the NAB Monthly Business Survey released on Wednesday showed a buoyant labour market.

As discussed above with respect to troubling inflation portents, it is difficult to see this report being inconsistent with another 50 basis point policy rate increase from the RBA in October.

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It is now time for a careful and independent review of ASX’s and Digital Asset’s (DA) work to date on the CHESS Replacement and the work needed to complete the project. It is critical that ASX and the market have a high degree of confidence and certainty in a new go-live date. Industry has mobilised significant resources to date and will need to continue to invest to ensure a successful and safe launch of the CHESS replacement.

Despite the delay, the regulators expect ASX to replace CHESS as soon as this can be safely achieved by ASX and users of CHESS. CHESS is a critical clearing and settlement (CS) system for the Australian cash equity market. A stable and reliable CHESS replacement will be important to maintain investor confidence in Australian financial markets and the stability of the financial system.

ASIC Chair Joseph Longo said, ‘It is very disappointing that there is a further delay to the CHESS Replacement Project. Given the delays and duration of the project, it is critical that Accenture now undertake this review to provide assurance on the delivery of a resilient replacement for CHESS and a high degree of confidence in a revised go-live date. To achieve this we expect ASX to publish the findings of the Accenture review. It is important that the Australian financial system is served well by contemporary infrastructure that is efficient, resilient, reliable and scalable to meet existing and future needs of the market and participants.’

RBA Governor Philip Lowe said, ‘The delay in the go-live date for the CHESS replacement system is disappointing. The review initiated by ASX is an important step in providing assurance that the new CHESS application software will be fit for purpose. The replacement system must be safe and reliable to maintain investor confidence and the stability of Australia’s financial system.’

The regulators continue to closely monitor ASX’s compliance with its CS facility licence obligations, including the additional licence conditions imposed in November 2021. These additional conditions required an independent expert to be appointed as approved by ASIC to assess whether ASX’s assurance program for the replacement of CHESS is fit for purpose, identifying any shortfalls, and reporting regularly to ASIC. The independent expert, EY, has and continues to provide assurances over various aspects of the CHESS Replacement project.

Accenture’s review will form part of ASX’s assurance program and therefore be considered by the independent expert. Prior to go-live, ASX must provide all independent assurances to the independent expert and the regulators and provide senior executive and Board attestations. The independent expert must also provide to ASIC a report on the totality of the findings of the assurance reviews including whether remedial actions have been appropriately implemented by ASX.

At a minimum, the regulators’ expectations are that the new system must meet requirements that CHESS meets today for system availability, resilience, recoverability, performance and security. ASIC and the RBA will continue to closely supervise ASX’s CHESS replacement change program.

We expect ASX to continue to invest in and maintain the current CHESS system so that it continues to service the market reliably until the CHESS replacement can go live.

Background

ASIC and the RBA are co-regulators of licensed CS facilities.

The RBA and ASIC have supervisory responsibilities for the four clearing and settlement (CS) facilities in the ASX Group: two central counterparties – ASX Clear Pty Limited and ASX Clear (Futures) Pty Limited – and two securities settlement facilities – ASX Settlement Pty Limited and Austraclear Limited.

The RBA conducts annual assessments covering the CS facilities’ observance of relevant Financial Stability Standards determined by the RBA.

For more information on the RBA’s approach to supervising and assessing CS facilities, see: The Reserve Bank’s Approach to Supervising and Assessing Clearing and Settlement Facility Licensees.

ASIC has separate, but complementary, responsibilities for the licensing and supervision of CS facilities licensed under Part 7.3 of the Corporations Act. ASIC is responsible for assessing whether a CS facility’s services are provided in a fair and effective way. ASIC also has regulatory responsibilities for operators of licensed markets, including the ASX market. In carrying out supervision and assessments of CS facilities, the RBA and ASIC work closely as appropriate.

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Kanish Chugh

Precious metals prices have risen by around 10% in the past three months, as investors turn to alternative assets in the face of ongoing concern about a re-emergence of high inflation in the post-COVID economic environment.

Alternatives are also being sought as a source of uncorrelated returns to complement low-yielding fixed income and expensive equities.

ETF Securities Head of Distribution Kanish Chugh says gold and other precious metals have a proven track record as inflation hedges and appear to be demonstrating that characteristic now.

Inflation concerns have hung over markets for most of this year. In the latest development, in mid-June US Federal Reserve Chairman Jerome Powell said inflation had come in ahead of expectations and could end up higher than the Fed’s current forecast of 3.4% for 2021, which up from a forecast of 2.4% three months ago. Powell also said the Fed expects to start raising interesting rates next year, with two increases by 2023.

Around the same time, Reserve Bank of Australia Governor Philip Lowe said he expects the June quarter consumer price index will show a spike in inflation to 3.5% due to the unwinding of some pandemic-related price reductions. But beyond that point, inflation pressure will be subdued.

Chugh notes: “Among the alternatives to fixed income and equities on offer – commodities, hedge funds, private equity, direct property and collectibles – commodities have a number of advantages.

“One group of commodities, precious metals, trade on exchanges through exchange traded funds. Because of this they provide a high degree of transparency, investment costs are low and they are liquid.”

ETF Securities provides exposure to precious metals through ETFS Physical Precious Metals Basket (ASX code: ETPMPM), which is backed by physical allocated metal held by a custodian, JP Morgan Bank. ETPMPM tracks the Metals Basket Composite, which is the weighted average benchmark price of the London Bullion Market Association’s prices for gold, silver, platinum and palladium.

ETFMPM has produced an average return of 12.9% a year over the five years to the end of May, which is ahead of the Australian share market return over the same period. Over the past 12 months it has returned 10.4%.

Over the past three months the Fund is up 9.9 per cent, a strong performance that is in response to fears of rising inflation. Its current metal allocation is 41% gold, 33.3% palladium, 18.7% silver and 7% platinum.

Numerous studies over the years have shown that returns from mainstream asset classes suffer when inflation spikes but the returns of gold and other precious metals tend to move into the double digits.

Chugh cites a recent study by Campbell Harvey, professor of finance at Duke University, which reaffirmed that precious metals may be the most appropriate inflation hedge.

“Precious metals also offer portfolio diversification. They have no internal rates of return, unlike shares and bonds, and so their priced are set entirely by supply and demand.

“Whereas demand for most commodities is cyclical, rising and falling with economic activity, precious metals have both cyclical and countercyclical demand. Cyclical demand comes from industrial use, such as jewellery making for gold and silver, and car manufacturing for palladium.

“Countercyclical demand shows itself in demand for gold when stock markets fall. Gold is often referred to as an event risk hedge, producing positive returns when unexpected events occur. It did this during the 1987 share market crash, the 1990 Iraq war, the Russian debt crisis of the late 1990s, the bursting of the dotcom bubble in the early 2000s and the US equity bear market in 2008.

“The inclusion of other metals adds other characteristics: silver’s industrial uses are broader, including in solar panels; platinum is used in engine manufacturing but also has a role in emerging clean energy technology as a catalyst in hydrogen fuel cells; palladium is a key component for scrubbing pollutants from diesel engines,” notes Chugh.

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MetLife Australia’s Senior Internal Auditor, Aoife Donnelly, has been named one of The Banking and Finance Oath (BFO) Young Ambassadors for 2021.

Ms Donnelly was announced as a BFO Young Ambassador, along with ten others from across the financial services and banking industries at an event held last night at The Ethics Centre. The event was also attended by Philip Lowe, Governor of the Reserve Bank of Australia, John Laker AO, Chairman of the BFO and Simon Longstaff AO, Executive Director of The Ethics Centre.

The BFO Young Ambassador Program encourages and supports students and graduates to adopt a strong ethical foundation as they begin their careers in the banking and finance industry. Ms Donnelly is the only BFO Young Ambassador from a life insurance company.

Having graduated from a finance degree in Ireland as the world suffered the impact of the global financial crisis of 2008, Ms Donnelly says, “I saw first-hand how a community suffered financially through the ethical failings of the financial services system.” This experience guided her career and has inspired her to drive high ethical standards from herself and colleagues.

“As a BFO Young Ambassador, I hope to encourage others to restore trust and confidence in the industry. I also want to learn from other BFO Young Ambassadors by engaging in difficult and thought-provoking conversations to inspire continued change in a post-Hayne environment.”

Commenting on the BFO Young Ambassador Program, Head of The BFO, Cris Parker said: ”Recognising the power of the individual, MetLife has taken the lead within the insurance sector by raising awareness of The BFO and supporting Aoife as a Young Ambassador to demonstrate her commitment to ethics and in turn, strengthen the ethical foundation in their organisation.”

MetLife has a long-standing commitment to the BFO and runs an annual campaign to engage staff with the guiding principles of the BFO, achieving a 40% uptake of the Oath in 2020. MetLife has also led the life insurance industry by encouraging others to take the Oath and advocating for improved ethical standards.

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The BFO unveils the 2020 cohort of Young Ambassadors.

The Banking and Finance Oath (The BFO) is proud to introduce the 2020 cohort of Young Ambassadors – a Program encouraging and supporting students, graduates and young people to contribute to a strong ethical foundation as they begin their careers in the banking and finance industry.

As a strong supporter of The BFO, the Governor of the Reserve Bank of Australia, Philip Lowe, has announced the 2020 cohort, acknowledging the importance of trust, integrity and ethics in fostering a positive culture within the industry.

“Finance is all about trust. When a deposit is placed in a bank, we trust it will be repaid. We also trust financial institutions to invest our hard-earned savings for us. And we trust them to provide us with sound advice. Without this trust, the financial system cannot operate properly and the economy cannot prosper. As the first line of The Banking and Finance Oath says: ‘Trust is the foundation of my profession’. The Young Ambassadors, as future leaders in the industry can help to rebuild trust in finance through the example they set” said Governor Lowe.

Recognising young people as the future leaders of the industry, Governor Lowe congratulated the seven successful candidates, who have demonstrated a strong commitment to ethics in banking and finance:

• Louisa Brown, Graduate, NAB
• David Goldfeld, Graduate, UBank
• Elle Griffin, Senior Analyst, CBA
• Michelle Lim, Consultant, KPMG
• Ricky Rangra, Student, The University of Sydney
• Anu Sharma, Graduate, NAB
• Sarah Valente, Graduate, ANZ

Chair of The BFO, Dr John Laker AO said, “In these unprecedented times, the banking and finance industry is playing a vital role in supporting the Australian community through hardship. Our industry may change after the COVID-19 pandemic is tamed but that is difficult to know. What we do know, though, is that our Young Ambassadors have the leadership qualities to help influence positive change and set an example of honesty and integrity for their peers”.

Recognising the Young Ambassador Program can reach only a limited amount of young people within tertiary institutions, The BFO is working with universities across Australia to introduce the Oath to young people in their banking and finance degrees. The aim of this collaboration is to support young people going into financial services who lead with their values, and work with their organisations to strengthen the ethical foundation of the industry.

Academic Director for Postgraduate Programs in the University of New South Wales Business School, Tracy Wilcox said, “We know that young people are more interested in living a life with purpose. And we are seeing the importance of trust and integrity in underpinning flourishing societies and economies. The BFO Young Ambassador Program enables emerging leaders in the banking and finance industry to make a positive difference in their field. I hope to see more and more of our students embrace the values and practices that The BFO embodies.”

The Young Ambassador Program offers the opportunity for young people to participate in a 12-month Program, including training and development, exposure to industry leaders, access to The BFO events and a chance to connect with an elder of the industry. The Program allows participants to harness the full potential of The BFO in their workplace. On completion of the Program the group is required to deliver a project that contributes to the ongoing conversation exploring ethics.

You can find out more about the Program, past projects and the 2020 Young Ambassadors on The BFO website.

The BFO presents ‘Ethics in Financial Services‘ podcast series

The project delivered by the 2019 Young Ambassadors saw the group produce a podcast series featuring interviews with senior members of the banking and financial services industry. Among those interviewed were Jillian Broadbent AC, member of the board of the Reserve Bank of Australia, Chair of the Clean Energy Finance Corporation and Chancellor of the University of Wollongong, and Stephen Dunne, former CEO of AMP Capital and first Chairman of The BFO Ltd.

In each interview, guests shared their story about an ethically challenging decision they were faced with during their career. Each episode presents a tangible case study from which other members of the industry can draw when facing their own ethical challenges.

You can listen to the podcast series ‘Ethics in financial services’ on The BFO website and other podcast platforms.

This podcast series will continue to provide past and present Young Ambassadors the opportunity to talk with leaders who are able to share challenging times. This will allow a continuous learning for future leaders.

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Inflation: The Consumer Price Index – the main measure of inflation in Australia – rose by 0.4 per cent in the June quarter, below expectations for a lift of 0.5 per cent. In seasonally adjusted terms the CPI rose by 0.5 per cent. The annual rate of headline inflation lifted to 2.1 per cent in the June quarter from 1.9 per cent in the March quarter. But the seasonally adjusted annual growth rate lifted to 2.2 per cent (also from 1.9 per cent).

Underlying measures: The Reserve Bank monitors three measures to derive the underlying inflation rate. The trimmed mean rose by 0.5 per cent in the June quarter (1.9 per cent annual); the weighted median rose by 0.5 per cent (1.9 per cent annual) and the CPI less volatile items rose by 0.2 per cent (1.8 per cent annual). Overall, underlying inflation rose by 0.5 per cent in the quarter and by 1.9 per cent over the year. Market goods and services less volatile items was up by 0.2 per cent in the quarter to be up 1.1 per cent on the year.

Main changes: Automotive fuel prices rose by 6.9 per cent in the June quarter, followed by medical and hospital services (up by 3.1 per cent) and tobacco (up by 2.8 per cent). But domestic holiday travel and accommodation prices fell by 2.7 per cent, followed by motor vehicles (down by 2.0 per cent) and vegetables (down by 2.9 per cent).

What does it all mean?

The Reserve Bank is likely to be unmoved by today’s inflation report. Consumer prices remain well contained, reflecting lacklustre wages growth, and aggressive price discounting and competitive pressures from global e-commerce entrants into the retail sector.

And Aussie businesses are playing their part keeping costs under control by supressing wages growth. The NAB business survey for the June quarter, released last week, highlighted that business prices tracked sideways. In fact the NAB said, “The range of both input and final price indicators (labour costs, purchase costs and final products prices) suggest little, if any significant price pressures. Retail prices growth also tracked sideways at a very low rate. Wholesale price inflation slowed in the quarter, suggesting some further downstream price weakness.”

That said, by generating higher sales and record profits, corporate Australia has supported strong jobs growth over the past 18 months. Non-mining business investment is strengthening and the miners are beginning to generate strong free cash flow, supporting future capital equipment and exploration spending. The broader pick-up in economic activity and emerging skills shortages in some industries (i.e. STEM, construction and mining) are expected to lead to eventual pay rises for workers, gradually lifting consumer prices.

The lift in imported (tradables) inflation was unsurprising. Fuel prices have lifted globally on the back of OPEC and Russian crude oil supply restraint. CommSec produces a weekly report detailing movements in Australia’s petrol prices. The national average Australian price of unleaded petrol has been near 3 year highs for much of this year. In fact, the annual increase in petrol prices to June 30 was 24.8 per cent – the strongest growth rate in 9½ years. So the 6.9 per cent lift in petrol prices was always going to be a strong overall contributor to imported prices.

Where will the higher rate of inflation eventually come from? With oil prices likely to weaken after the OPEC-Russia Vienna accord to lift production, the severe drought afflicting large parts of Australia could be a source of inflation. Extremely dry weather conditions are already impacting winter crop and livestock production, as observed recently by agribusiness companies, Nufarm and Elders. The US Department of Agriculture has cut its Aussie wheat production estimate by 12 per cent to 22 million tonnes in 2018/19 – the lowest level in 11 years. And rising Indian tariffs and dry weather will likely halve Australia’s chickpea output to around 500,000 tons this year.

The Reserve Bank won’t be touching interest rates any time soon. The Board’s preferred underlying inflation rate remains low and it is still struggling to get anyway near the mid-point of the Board’s 2-3 per cent target. Reserve Bank Governor Philip Lowe says he would like to see inflation at a 2.5 per cent annual rate with wage growth at 3.5 per cent, but there is still some spare capacity in the labour market.

The Reserve Bank expects underlying inflation to hold near 2 per cent for the next 18 months. The Bank will revisit these forecasts in the next quarterly Statement on Monetary Policy on August 10.

By Ryan Felsman, Senior Economist

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Philip Lowe

The Reserve Bank Governor Philip Lowe delivered a speech in Adelaide last night.

Key points

• Statement on Monetary Policy: Governor Lowe flagged changes to the format of the report to “make the report more thematic”.
• Forecasts: “The latest forecasts should not contain any surprises, with only small changes from the previous set of forecasts, issued three months ago. This year and next, our central scenario remains for the Australian economy to grow a bit faster than 3 per cent…. Inflation is expected to remain low, at around its current level for a while yet, before gradually increasing over the next couple of years, towards 2½ per cent.”
• Inflation outlook: “….inflation has troughed, although it remains low. Strong competition in retailing is holding down the prices of many goods: for example, over the past year, the price of food increased by just ½ per cent, the price of clothing and footwear fell 3½ per cent and the price of household appliances fell 2½ per cent. Importantly, these outcomes are helping to offset some of the cost of living pressures arising from higher electricity prices, which nationally are up 12 per cent over the past year.”
• Wages outlook: “And in terms of the inflation target, it is difficult to see how a continuation of 2 per cent growth in wages is compatible with us achieving the midpoint of the inflation target – 2½ per cent – on a sustained basis…. we are hearing a few more reports of larger increases in those areas where there is a shortage of workers with the necessary skills. After all, the laws of supply and demand still work. We also see evidence in the aggregate data that wages growth has troughed and we expect to see a further pick-up. This is likely to be a gradual process, though.”
• Household sector: “Domestically, for some time, we have seen the main risk to be related to household balance sheets. For a while, trends in household credit were quite concerning. On this front, things now look less worrying than they were a while back, although the level of household debt remains very high, which carries certain risks.”
• Overseas risks: Risks basically lie in the “international arena”. The Governor highlighted protectionism and Chinese debt as well as the domestic risk of high household debt.
• Tighter conditions? “In terms of financing, we also discussed the potential for some tightening in financial conditions in Australia. In the United States, the cost of US dollar funding has increased for reasons not directly related to monetary policy and this increase is flowing through into higher money market rates in Australia. We expect some of this to be reversed in time, although it is difficult to tell by how much and when. It is also possible that lending standards in Australia will be tightened further in the context of the current high level of public scrutiny. We will continue to watch these issues carefully.”
• “Gradual” is the word: “The other key point is that the progress we are making is only gradual: our central scenario is for a gradual pick-up in wages growth, a gradual lift in inflation, and a gradual reduction in the unemployment rate.”
• Interest rates outlook: “If this is how things turn out, it is reasonable to expect that the next move in interest rates will be up…the best contribution we can make to the welfare of the Australian people is to hold the cash rate steady and for the Reserve Bank to be a source of stability and confidence.”

What does it all mean?

• Interest rates are on hold. The next move in rates is up if the RBAs scenario plays out. The Reserve Bank Governor remains upbeat, expecting the economy to grow by around 3 per cent in 2018 and 2019. Interestingly, the presumed “speed limit” of the economy – the point where inflation starts to rise – is around 2.75 per cent.

Full speech: http://www.rba.gov.au/speeches/2018/sp-gov-2018-05-01.html

By Ryan Felsman, Senior Economist

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