September quarter CPI: the RBA “experiment” vindicated…hopefully!

The September quarter consumer price index (CPI) did not add a whole lot to the market’s information set regarding assessments of the likely timing of a policy rate cut from the RBA.

Sure, the headline rate was a little better than expected coming in at an annual rate of 2.8 per cent. That reflected the impact of government subsidies for electricity consumption for which there will be an offsetting increase in the future. Falling fuel prices also contributed.

The RBA’s favoured trimmed-mean measure came in at 3.5 per cent, which is consistent with the most recent RBA forecast made back in August.

The “good news” is that the result means that any prospect of a policy rate hike has disappeared from the RBA agenda.

That would be consistent with the RBA Governor’s acknowledgement back in September that the September RBA Board meeting did not explicitly discuss a policy rate hike, although she was careful to downplay the prospect of any near-term policy rate cut.

In that context, today’s result would appear insufficient to elicit any policy rate reduction in 2024, particularly given ongoing “sticky” services inflation.

Services inflation increased at an annual 4.6 per cent, up from 4.5 per cent in June. Moreover, as the NAB economists point out, a subset of services closely watched by the RBA as in indicator of domestic demand pressure, market services inflation excluding travel and telecommunications, grew by a strong 1.2 per cent in the quarter and 5.2 per cent on an annual basis.

With a labour market in (arguably surprisingly) good health and with inflation heading back to target in an elongated fashion it is almost impossible to see a policy rate reduction in 2024.

My best guess for a policy rate reduction (and “guess” is the operative word) remains February 2025, with the balance of risks leaning toward a later rate cut than one any earlier than that time.

As has been widely discussed, the RBA has differed from other developed country central banks in that it showed a reluctance to raise rates as far and as fast. This is the self-described RBA “experiment”.

The upside of that approach has been relatively better labour market outcomes.

The downside has been relatively “stickier inflation”.

And what that suggests is that in Australia policy rate adjustments on the downside will lag those in other developed countries.

In my view, economic developments through 2024 have by and large vindicated the RBA “experiment”.

That is a point lost by the at times ill-informed, even febrile, commentary from current and former politicians who have been critical of the Governor and her deputy.

That said, and as the RBA Board has acknowledged, there is a risk that the ‘pickup [in household spending] is slower than expected, resulting in continued subdued output growth and a sharper deterioration in the labour market.’?

There is, as yet, no evidence of that ‘sharper deterioration in the labour market’.

Nevertheless, such deterioration is a non-trivial risk and one to which the RBA would certainly need to respond.

In my view the RBA may soon be in a position to see some light at the end of the tunnel on inflation and may well avoid any dramatic dislocation in the labour market.

The most recent NAB Business Survey revealed some “straws in the wind” that inflation has stepped down in a manner that will allow the RBA to more confidently judge that inflation is heading sustainably back to target in line with the forecasts issued in August.

The NAB Survey also revealed more resilient business conditions including for the labour market and employment.

If, as I suspect, labour market outcomes and inflation outcomes will be broadly in line with RBA forecasts, then the RBA might reasonably expect to cut rates in February.

That said, challenges remain.

As worthy as the RBA “experiment” may have been, inflation is still indubitably “sticky” – more so than in the rest of the developed world.

The RBA’s inflation containment task has also been frustrated by counter-productive government policies. ?

Fiscal policy in Australia, mostly (but not exclusively) at the state government level has not helped.

(It should be acknowledged that fiscal policy encompasses a lot more than just a narrow inflation focus, extending as it does to distributional, welfare, and educational objectives, to name just a few elements. That is not to say that some of those objectives are poorly targeted – think big-spending state governments purporting to provide cost-of-living relief.)

Nevertheless, the pursuit by various levels of government of their fiscal objectives will increase aggregate demand by around 2 percentage points of GDP in 2024-25.

With excess demand a primary driver of inflation, that government contribution remains problematic for the RBA. ??

Of significance are also productivity / wage developments.

Annual unit labour cost growth (the most relevant labour cost gauge for inflation) is growing at over 5 per cent, according to the most recent – if admittedly dated – June quarter national accounts. It remains difficult therefore to project any abatement of the “stickiness” in inflation meaningfully beyond that currently projected by the RBA.

As I have written in the past, the productivity challenge is given some poignancy by recent changes in the regulatory environment in Australia, particularly in relation to the wage-setting and the industrial relations framework. These changes potentially exacerbate an already stubborn inflation problem. They are broadly inimical to productivity growth, and they weaken the link between productivity and nominal and real wage growth, potentially entrenching higher inflation in Australia compared to elsewhere particular, even if economic activity weakens.

So, while February remains a best guess for the first policy rate cut in the cycle, the various challenges confronted by the RBA, including those thrown up by governments, mean there is a risk that the reduction comes later.

However, and despite those challenges, the RBA “experiment” appears to be negotiating that metaphorical “narrow path” between declining inflation and minimising labour market dislocation.

It is certainly doing so in a much better manner than many of its peers.

We can only hope that continues.?

Stephen Miller is an Investment Strategist with GSFM. The views expressed are his own and do not consider the circumstances of any investor.