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Australia’s annual inflation rate rose to 1.1%, year-on-year, in the first quarter of 2021, up from 0,9% in Q4 of 2020, well below the market consensus of 1.4% and below the RBA’s official target band of 2-3%. The Covid-19 pandemic remains well contained domestically, which shows up in steadily improving economic indicators, especially in the labour market. However, the vaccine rollout is behind schedule and thus proving costly for the economy overall. The RBA Shadow Board’s conviction that the cash rate should remain at the historically low rate of 0.1% remains exceptionally strong: it remains very confident that this is the appropriate interest rate setting.
Australian labour market statistics continue to improve. The official ABS unemployment rate fell yet again, from 5.8% in February to 5.6% in March. In the same period, total employment increased by just over 70,000, but full time employment fell by nearly 21,000. Youth unemployment fell by more than a full percentage point for the second month in a row, to 11.8%. The labour force participation rate increased by 0.2 percentage points, to 66.3%, and the significant increase in job advertisements and job vacancies is likewise painting a favourable picture of the Australian labour market. Despite the improving statistics, there remains considerable slack in the Australian economy, including the labour market, and so it is unlikely that recent developments will lead to wage and price pressure in the near future.
The Aussie dollar remains largely range-bound between 76 and 78 US¢. Likewise, yields on Australian 10-year government bonds moved sideways, mostly staying within the 1.7-1.8% range. The shapes of the yield curves remain unchanged for yet another month: the yield curve in short-term maturities (2-year versus 1-year) is flat, bearing in mind that this reflects the RBA’s policy choice; in mid-term versus short-term maturities (5-year versus 2-year) and in higher-term maturities (10-year versus 2-year) the yield curves display normal convexity. The spread between the 10-year rate and the 2-year rate has barely budged, at 163 basis points. The Australian stock market, after pausing for two months, resumed its climb, with the S&P/ASX 200 stock index now trading above 7,000.
While the vaccine rollout in Australia is disappointingly slow, other developed nations have made considerable progress. In the US more than half of the adult population has received at least the first jab of the Covid-19 vaccine. Uğur Şahin, the head of BioNTech, Pfizer’s partner and developer of one of the vaccines, confidently announced that the pandemic would be largely contained, at least in Europe and North America, by August/September. If this prediction is accurate and Australia’s vaccination program gathers significant pace, international border restrictions may well be eased in the second half of 2021, which would provide a significant economic boost.
Australian consumers are becoming increasingly confident about the state of the economy: the Melbourne Institute and Westpac Bank Consumer Sentiment Index rose 7 points, to 119. Retail sales (month-on-month) expanded by a sizeable 1.4% in March. Private sector credit grew by 0.4% month-on-month, the largest positive change since the abnormal spike at the beginning of the pandemic in 2020. NAB’s index of business confidence weakened slightly to 15 in March; the manufacturing and services PMIs, on the other hand, strengthened further, from 58.8 to 59.9 and from 55.8 to 58.7 in March, respectively. Capacity utilisation also continued to increase, by more than half a percentage point, to 82.35% in the same month, the highest reading in nearly three years.
There is little evidence the boom in the housing market is abating in the immediate future. House prices in capital cities are climbing further and clearance rates are very high, nearly 80% on average. Remarkably, the AI Group/HIA Australian Performance of Construction Index jumped 4.4 points to an all-time record high of 61.8 in. It is unlikely the RBA will respond to the housing market’s strength by raising the cash rate, so most analysts concerned about the price rises and the associated economic dislocations, are looking to APRA to adjust lending standards.
For six months, the official cash rate target has been at the unprecedented level of 0.1%. The Shadow Board’s conviction to keep the overnight interest at 0.1% remains exceptionally strong. The Board attaches a 98% probability that the overnight interest rate should remain steady (99% in April), a mere 2% probability that an increase is appropriate (1% in April) and a 0% probability that a further rate cut to below 0.1% is appropriate.
The probabilities at longer horizons are as follows: 6 months out, the confidence that the cash rate should remain at 0.1% equals 80% (78% in April), the probability attached to the appropriateness for an interest rate decrease remains at 1%, while the probability attached to a required increase remains at 19%. One year out, the Shadow Board members’ confidence that the cash rate should be held steady equals 64% (72% in April). The confidence in a required cash rate decrease, to below 0.1%, is 1% (unchanged from April) and in a required cash rate increase 35% (27% in April). Three years out, the Shadow Board attaches a 9% (13% in April) probability that the overnight rate should equal 0.1%, an unchanged 1% probability that a rate lower than 0.1% is appropriate, and a 91% (87% in April) probability that a rate higher than 0.1% is optimal. The range of the probability distributions over the 6 month and 12 month horizons spans from 0% to 1.25%, 25bp wider than in the previous month, and the range of the probability distribution for the 3-year recommendation is unchanged, extending from 0% to 2.5%.
Yesterday’s inflation print doesn’t fundamentally change my view of the position of the economy. Employment growth continues to impress, and capacity constraints are starting to appear in some sectors for some jobs (particularly skilled labour). But this is unlikely to spill over to a broad-based pick-up in wages growth in the near term. There is still ample spare capacity in the economy, much of which is captured in the standard labour market metrics (as indicated by the rising participation rate), and this will need to be absorbed before pressures generally start to build in the labour market. Moreover, those that are currently out of work or working fewer hours than they would like may not be able to pivot into the sectors where demand is strongest. How the labour force works through this transition over the next 12-24 months (and what happens with the international border and the return of migrant workers and students) will be crucial determinants of when and how wage and price pressures materialise.
Updated: 12 May 2021/Responsible Officer: Crawford Engagement/Page Contact: CAMA admin
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