RBA: Keeping hawkish pause in March with labor market still at early stage of cooling

The Reserve Bank of Australia (RBA) appears to remain concerned about inflation since it remains sticky. While the downward trend has been driven by softer goods prices, the headline CPI stood at +3.4% YoY in January, with stable inflation in services at +3.7% YoY (Chart 1). If we focus on the trimmed mean, RBA’s preferred measure of underlying inflation, it actually rose +3.8% YoY in January, which suggests that volatile items on goods have been driving goods inflation. On the other hand, surging housing rents and the strong labor market have been behind the sticky services inflation.

The labor market is at an early stage of cooling. While hours worked declined, the unemployment rate rose to 4.1% in December (Chart 2). Because this is still below the non-accelerating inflation rate of unemployment estimated between 4.5% and 5.0% by the Australian Treasury, wage pressure remains strong. In fact, wages picked up to +4.2% YoY in Q4-23, which could have supported the resilient housing market lifting rents. These developments suggest that inflation is homegrown, as argued by the RBA Governor Bullock.

Finally, corporate earnings have been better than expected, with more companies reporting larger profits rather than those with weaker profits. These results arguably reflect tighter cost control, because revenue growth slowed while interest expenses increased. Hence, the labor market could face stronger headwind, if the RBA tighten further.

The sticker than expected inflation and positive labor market and corporate earnings call for a pause in rates until more data is released but certainly not a hike. After the RBA hiked by 425 bps from early 2022, higher mortgage payments, which is estimated by the Reserve Bank at about 10.5% of disposable income, have eroded consumers’ purchasing power. On the back of these developments, falling consumer confidence have weakened retail sales.

Therefore, the RBA is anticipated to remain on hold with a hawkish stance at the March meeting by carefully managing the delicate balance between sticky inflation and consumer confidence. In fact, the Fed could offer a helping hand, by cutting rates at some point in mid- 2024 as a stronger Aussie would help contain inflation. However, Fed cuts do not seem very likely soon, based on still high inflation data.

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