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The annual (headline) CPI inflation rate in Australia jumped to 5.1% in the first quarter of 2022, up from 3.5% in Q4 of 2021 and 0.5 percentage points higher than the consensus forecast. The RBA Trimmed Mean CPI increased by 3.7% (up from 2.6% in the December quarter), well above the RBA’s official target band of 2-3%. The latest GDP growth figure of 3.4% is still from the December quarter of 2021. The RBA Shadow Board’s verdict has shifted in favour of a rate rise. Although “no change” is the mode recommendation, the Shadow Board is only 47% confident that keeping the cash rate steady at its historic low is the appropriate policy setting. Correspondingly, it attaches a 53% probability that an interest rate increase to 0.25%, or higher, is appropriate.
The official ABS (seasonally adjusted) unemployment rate held steady at 4% in March; youth unemployment remains above 9%. Total employment increased by 17,900 and full-time employment by 20,500. The labour force participation rate, at 66.4%, did not budge. The underemployment rate dropped slightly to 6.3%, while monthly hours worked contracted by 0.6%. The RBA stated some time ago that it would like to consider the newest data on the wage price index (WPI), to be released on 18 May, before deciding on a possible interest rate increase. Indeed, given the high rate of headline inflation, next month’s WPI will provide significant information about the wider inflationary pressures in the economy.
The month of April has seen the Aussie dollar plummet from a local high of 76 US¢ to just above 71 US¢. Yields on Australian 10-year government bonds continued to rise, from a recent low of approximately 1.65% four months ago to 3.16% on the last week day in April. Yield curves retain their normal convexity. Interest rate spreads have narrowed along all segments of the yield curve, from short-term maturities (2-year versus 1-year) to higher-term maturities (10-year versus 2-year), indicative of an overall flattening of the yield curve. Australian stock prices have consolidated after a brief weak spell in the previous month; the S&P/ASX 200 stock index is trading near 7,400, 100 points lower than one month ago.
The outlook for the global economy is darkening in the face of commodity shortages, high fuel prices, and disrupted global supply chains, with the IMF in its April World Economic Outlook revising down global GDP growth forecasts to 3.6% in 2022 and 2023. Coupled with large fiscal stimuli in many economies, the supply-side constraints have dramatically pushed up global inflation rates, to as high as 8.5% in the US. Numerous central banks have raised their cash rate recently, including the Federal Reserve, the Bank of Canada, the Bank of England, and the Reserve Bank of New Zealand. All central banks have flagged further rate rises in the coming months, adding pressure on the RBA to follow suit. The Ukraine war and rising geopolitical tensions elsewhere add to the tail risks, raising the possibility – according to some financial market analysts – of the world economy slipping into recession in 2023, or earlier: the US economy contracted by an annualized 1.4% in the first quarter of this year.
Australian consumer confidence softened for the fifth consecutive month; the Melbourne Institute and Westpac Bank Consumer Sentiment Index fell from 101 in February and 96.6 in March to 95.7 in April. Private sector credit growth slowed from 0.6% month-on-month, to 0.4%, largely attributable to a contraction in consumer credit. NAB’s volatile index of business confidence improved for the third month in a row, coming in at 16 in March, compared to 13 in February. In the same period, the manufacturing PMI likewise improved slightly, from 53.2 to 55.7, while the services and PMI deteriorated from 60 to 56.2. The capacity utilization rate is continuing to recover from a recent trough, posting a 0.6 percentage point gain to 83.1%. The Westpac-Melbourne Institute Leading Economic Index for March rose by 0.3% year-on-year, after a revised increase of 0.4% in the previous month; the IHS Markit Australia Composite PMI is likewise indicative of an economic expansion.
The official cash rate target has been at the historic level of 0.1% for 17 months. The Shadow Board’s conviction to keep the overnight interest rate at this historic low weakened considerably. While “no change” is the mode recommendation, the Board only attaches a 47% probability that this is the appropriate policy (down from 86% in April) and a 53% probability that an increase is appropriate (up from 13%).
The probabilities at longer horizons are as follows: 6 months out, the confidence that the cash rate should remain at 0.1% weakened further, from 33% in April to 21% in the current round; the probability attached to the appropriateness of an interest rate decrease remains unchanged at 0%, while the probability attached to a required increase correspondingly rose from 67% to 79%. One year out, a similar picture emerges. The Shadow Board members’ confidence that the cash rate should be held steady fell again, from 13% in April to 4% in this round. The confidence in a required cash rate decrease, to below 0.1%, is 0% (unchanged) and in a required cash rate increase 96% (88% in April). Three years out, the Shadow Board attaches a 7% probability that the overnight rate should equal 0.1% (unchanged) and a 93% probability that a rate higher than 0.1% is optimal (also unchanged). The range of the probability distributions widened, reflecting a reassessment by at least some members of the tail risks: for the 6-month horizon it extends from 0.1% to 1.75% (compared to a range of 0.1% and 1% in the previous round), for the 12-month horizon from 0.1% to 2.5% (compared to a range of 0.1% and 2% in the previous round), and for the 3-year recommendation from 0.1% to 4.25% (compared to a range of 0.1% and 4% in the previous round).
With 8.5 (7.5) per cent inflation in the U.S.A. (Euro area), the release of the Consumer Price Index for Australia on April 27th was long-awaited. And I believe it is higher than expected. The year-ended C.P.I. inflation (trimmed mean) is now at 5.1 (3.7) per cent. These are clearly above the 2-3 per cent target and the highest we have experienced in a decade.
Two items that have contributed greatly to this are fuel (due to the war in Ukraine) and construction costs (due to supply chain disruptions). None of the underlying conditions are resolved and I believe we should expect further price increases through those channels. Australian households have also been hit hard by the increasing food prices. Inflation is not only affecting families negatively, but also businesses. According to today’s (28th of April) release on Business Conditions and sentiments, 57 per cent of all businesses experienced increases in their operating costs in 2022 and 48 per cent have passed such increases in costs (either partially or fully) through increasing prices to the customers.
Given this economic situation, I believe it is now appropriate that in the May meeting, the policy target cash rate finally lifts off.
The latest CPI data has confirmed that price pressures are broadening across the economy. While rises in fuel, food and building commodities accounted for a significant proportion of the rise in headline inflation, accelerating wages growth (particularly in construction) and continued robust rises in rents outside of Sydney and Melbourne are signs that price pressures are building domestically. Together with the latest labour force survey, the data continues to indicate that the economy is operating close to full employment.
Given this, the emergency monetary policy settings are no longer required and the cash rate should be raised from its current level; and with the RBA appearing to agree, it’s likely that the RBA Board will begin policy tightening at its May or June meeting.
Moving through the rest of 2022, growth momentum should remain positive but is likely to slow. The easy wins from re-opening have been largely exhausted, and households are now being squeezed by higher costs of living (though the latest Federal budget will help offset some of this) and rising mortgage interest rates. Momentum in government spending and business investment is also likely to moderate, although spending in both categories is set to remain elevated compared to the recent past, and while the re-opening of the international border will allow international students and tourists to return it will also enable Australians to travel overseas (and so increase import leakages).
Against this backdrop, a steady but not necessarily aggressive pace of hikes should hopefully result in a soft landing for the economy, where inflationary pressures ease (helped by the sharp increases in commodity prices dropping out) but the labour market remains relatively tight – compared to other developed economies (most notably the US, where rates are set to rise very sharply), the RBA has more room to manage the slowdown in growth momentum.
The RBA should consider starting a raising cycle soon, especially given high headline inflation and expansive fiscal policy. But it makes sense for the RBA to stick to its plan of waiting to see more of an effect on wage growth before commencing raising rates to justify doing so even if future headline inflation falls back into the target range when one-off price shocks stop or reverse. Raising rates with higher inflation is ultimately about higher inflation expectations and stronger wage growth will be an important indicator of higher inflation expectations being entrenched within the target range.
Updated: 23 May 2022/Responsible Officer: Crawford Engagement/Page Contact: CAMA admin
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