Shadow Board’s Recommendation Finely Balanced

The monthly consumer price index (CPI) rose 4.9% in the twelve months to October 2023, down from 5.6% in the previous month. This compares to a quarterly inflation rate of 5.4% year-on-year in Q3. The most significant price rises were in housing (+6.1%), food and non-alcoholic beverages (+5.3%) and transport (+5.9%). The RBA’s Trimmed Mean CPI, which excludes the most volatile items, was 5.3% year-on-year, one tick lower than in the previous month, and still well above the RBA’s target band of 2-3%. The labour market, while still strong, is showing first cracks and business confidence is continuing to soften, according to latest figures, while the outlook for the global economy remains muted. The Shadow Board’s recommendation is evenly balanced. It attaches a 50% probability that the overnight rate should remain steady at 4.35% and a 49% probability that the overnight rate should increase to 4.60%, or higher.

The official Australian seasonally adjusted unemployment rate ticked up by 0.1 percentage points in October, to 3.7%, on the back of an increase in employment of 55,000 and a rise of the labour participation rate, from 66.8 to 67%. Job advertisements fell by three percent, and the underemployment rate stood steady at 6.3%. The youth unemployment spiked up from 8% to 9.2%. Though still noticeably resilient, the labour market appears to slowly react to the string of interest rate increases. Australia’s seasonally adjusted wage price index increased by 4% year-on-year in Q3 of 2023. While this constitutes the highest reading since Q1 of 2009, it remains less than inflation and implies a real wage reduction, as in previous quarters.

The Australian dollar finished the month of November a little over 66 US¢, approximately one cent higher than at the end of October. Yields on Australian 10-year government bonds retreated from their recent peak, to around 4.4%. The yield curve in short-term maturities (2y vs 1yr) remains inverted; the one in medium-term vs short-term maturities (5y vs 2y), after the October interest rate hike, is now also inverted. The yield curve in long-term vs short-term maturities is displaying normal convexity. The Australian share market followed a similar path to the Australian dollar, posting modest gains throughout November; the S&P/ASX 200 stock index managed to climb above 7,000.

Consumer confidence in November, as measured by the Westpac-Melbourne Institute Consumer Sentiment Index, retreated from 82, a six-month high, to 79.9. Private sector growth grew by 0.3% month-on-month in October 2023, nearly half the rate posted in the previous month, and the slowest rate since July. Virtually all the business indicators dropped in October: the Judo Bank Manufacturing PMI, the Composite PMI and the Services PMI all contracted, from 48.2 to 47.7, from 47.6 to 46.4, and from 47.6 to 46.3, respectively. The capacity utilisation rate continued to lessen, from 84.16% to 84.04% in October. The Composite Leading Indicator, at the lowest reading in more than three years, held steady. The Ai industry group indices, both for manufacturing and for services, are in deep negative territory. All these numbers together are unambiguously pointing to a further softening of the business sector.

Australia’s housing market continues to show strength. The CoreLogic Home Value Index increased 0.6% in November. This is less than in previous months but still the tenth consecutive monthly increase. In October, the seasonally adjusted estimate for total dwellings approved expanded 7.5%, way more than the market consensus of 1.4%, while the most recent figure on construction output revealed a 1.3% increase quarter-on-quarter in the three months to September, or 8.5% on an annual basis. The sustained strength of the housing market, despite the sequence of interest rate increases, poses an additional challenge to the RBA.

According to the Organization for Economic Cooperation and Development’s (OECD’s) most recent statement, “GDP growth has been stronger than expected so far in 2023, but is now moderating on the back of tighter financial conditions, weak trade growth and lower business and consumer confidence.” Risks to this outlook are skewed to the downside and include heightened geopolitical tensions as well as a larger-than-expected impact of monetary policy. For the world’s advanced economies growth is expected to continue to slow throughout 2024 and not recover until 2025, according to the Paris-based organization.

The Shadow Board’s current view of monetary policy is on a knife’s edge: it attaches a 50% probability that keeping the overnight rate, currently equal to 4.35%, on hold is the appropriate policy, while attaching a 49% probability that the overnight right should increase, to 4.6%, or higher.

The probabilities at longer horizons are as follows: 6 months out, the confidence that the cash rate should remain at the current setting of 4.35% equals 21%; the probability attached to the appropriateness of an interest rate decrease equals 24%, while the probability attached to a required increase equals 56%. The mode recommendation at this horizon is 4.35%.

One year out, the Shadow Board members’ confidence that the appropriate cash rate should remain at the current level of 4.35%, equals 20%. The confidence in a required cash rate decrease, to below 4.35% equals 47%, and its confidence in a required cash rate increase, to above 4.35%, is 33%. Three years out, the Shadow Board attaches an 11% probability that the overnight rate should equal 4.35%, a 77% probability that a lower overnight rate is optimal and a 12% probability that a rate higher than 4.35% is optimal.

The range of the probability distribution for the current recommendation remains relatively narrow, extending from 4.10% to 5.10%. For the 6-month horizon the range, extending from 3.10% to 5.85%, expanded by 25 bps. The range for the 12-month horizon, at 2.10%-6.10%, remained unchanged, whereas the range of the 3-year horizon widened to 0.85%-5.35%.