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RBA: To Hike Or Not To Hike?

Economists had expected Australia’s annual headline rate of inflation to tick up to 2.0% in the December quarter from 1.8% in September, but once again were proven wrong. Headline inflation rose to only 1.9% and underlying, or core, inflation remained unchanged at 1.8%.

The small rise in the headline rate belied a 10% increase in fuel costs in the quarter. Once again it was disinflation in discretionary items that dragged the numbers down. The RBA’s target zone for the core rate is 2-3% but despite record jobs growth over 2017, core inflation remains stubbornly below targeted level.

In the twentieth century it was a given that strong jobs growth would lead to increasing wages as the pool of available labour became smaller, and wages growth would lead to increased consumer spending. But now that we’re well into the twenty-first century, that relationship is breaking down – globally.

We might argue all day why that is the case. But if we consider, for example, that today’s computing power means one employee can do the job of a prior roomful, online shopping means less need for shop assistants, those enormous dump trucks used by miners now drive themselves…we could go on and on…we might be some way to understanding why more jobs does not necessarily translate into higher wages.

In Australia there’s a bit of a double whammy going on. Low wages growth is forcing consumers back to borrowing and away from discretionary spending as household debt levels, driven by hefty mortgage obligations, rise. At the same time, competition from new entrants in the supermarket space and the online shift and subsequent “globalisation” of discretionary markets means prices continue to fall amidst stiff competition, with Amazon leading the way.

Hence even if consumers are willing to spend, they are paying less and less for the same items.

It is the RBA’s view, and most economists agree, that wages growth will soon start to pick up. Macquarie’s economists are among that group, but remain “alert” to the possibility of downside surprise in the December and March quarter wages data, given “surprising” weakness in average wage increases in new enterprise bargaining agreements.

These releases will take precedence over lagged CPI numbers, Macquarie suggests. Meanwhile, Macquarie sees core inflation remaining below the 2-3% target band for another 12-18 months.

The economists at UBS note that despite surging household energy prices, booming jobs growth and last year’s minimum wage increase, the fact that wages growth remains near a record low and consumers are struggling is keeping inflation below target for the longest time on record. They see no RBA rate hike in 2018.

The Aussie

The great frustration for the RBA is the currency. Previously the central bank could not afford to cut rates to bring down the Aussie given a perceived housing bubble, but various macro-prudential controls have led to what appears now to be a cooling in the housing market. But after a year of solid jobs growth that might imply a rate hike, the Aussie continues to be a stumbling block.

Things are not playing to script. The Fed is now in a tightening phase which is leading to higher US rates, but the US dollar is going down, not up as it should be. The Aussie should by now be lower on a stronger greenback but the reverse is true, and the weak greenback is supporting stronger-for-longer commodity prices, which are supporting the Aussie.

The recent rise in the Aussie will be a headwind to Australian inflation moving forward, note Morgan Stanley’s economists. They do not see an RBA rate hike until the second half of 2019.

Rate Cut?

Most economists see inflation as taking a while yet to return to target, and thus the RBA on hold for some time. Credit Suisse economists don’t see a return to target anytime soon. Indeed, the bigger question for Credit Suisse is whether the RBA might actually be forced to cut rates again.

Despite the benefit of strong fiscal stimulus, population growth and terms of trade gains, the Australian economy has barely kept up with potential, Credit Suisse notes. Wages inflation remains subdued and at the same time, money supply growth continues to slow on the back of aforementioned macro-prudential tightening. These factors, say the economists, point to further disinflation in the period ahead.

Stability Risk

Central banks around the globe have plenty of critics – those who believe post-GFC emergency rate settings have been kept too low for too long. Rising asset prices aside, were there to be some new, unforeseen financial crisis, or even simply a blow-off in asset prices leading into recession, central banks have little to no firepower with which to respond.

The sooner rates can go back to “normal” levels, the sooner markets can feel comfortable that central banks are once again in a position to use monetary policy as a weapon in a downturn.

ANZ’s economists believe the RBA holds this concern. They believe the central bank will want to bring the “real” cash rate back to zero for the sake of financial stability. The real rate is currently the RBA cash rate of 1.5% minus inflation of 1.8%, or more than one 25 basis point rate hike difference.

ANZ is bucking the trend of believing the December quarter CPI numbers will keep the RBA in an extended holding pattern, rather they continue to forecast two rate hikes in 2018, with the first as early as May.

Their view is premised on an expectation core inflation will indeed rise to 2% by year-end. That forecast assumes that the December quarter wage price index, due for release later this month, shows a 0.5% quarter on quarter increase.

We will have to stay tuned.

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