The changes to the RBA’s economic forecasts in the quarterly Monetary Policy Statement last Friday show both why it needed to...
The changes to the RBA’s economic forecasts in the quarterly Monetary Policy Statement last Friday show both why it needed to hike the cash rate last week and why it may need to hike again. The RBA revised higher forecasts of GDP and inflation and lower forecast unemployment. Importantly, the RBA is now forecasting that underlying and headline CPI inflation will only just squeeze inside its 2-3% target band in December 2025 (latest forecast 2.9% compared with 2.8% in the August forecasts).
These latest RBA inflation forecasts mean that any upside surprises in data reports relating to the inflation outlook push achieving target inflation out beyond 2025. Inflation appears to be staying too high too long even in the RBA forecasts released last week. Any nudge higher and longer to those inflation forecasts would make necessary another rate hike.
The risks of upside data surprises abound in data releases over the next couple of months, but they may not show sufficiently to warrant a rate hike at the December policy meeting. Ahead of that meeting are the Q3 wage price index and the October labour force report, both out later this week, and the October monthly CPI out later in the month.
In the latest RBA economic forecasts, the wage price index rise for December (effectively Q4) 2023 is revised down to 4.0% from 4.1% in the August forecasts and the unemployment rate is revised down to 3.8% from 3.9% previously. A lower revised unemployment rate would usually go together with upward revision to wage growth, but the current growth phase in Australia is littered with unusual circumstances interrupting economic relationships and making economic forecasting more difficult than usual.
In the case of the labour market, the move from no immigration in the depths of the lock downs in the pandemic to sharp catch-up and record high immigration over the past year has boosted labour supply helping to keep wage growth subdued even with the unemployment rate staying very low. Greater than expected immigration has also boosted economic growth and added considerable demand for housing, boosting house prices, rents and inflation.
Forecasters, including RBA forecasters, are all struggling to factor into their economic forecasts the disparate influence of unprecedented immigration on their growth, labour force and inflation forecasts. Nevertheless, the near-term impact from high immigration on wage growth is towards moderation and on the labour market greater employment and a stickily low unemployment rate.
Looking at the key data reports due this week, given the latest RBA forecast of 4.0% wage price index growth at the end of this year, the Q3 wage price index would need to come in higher than expected 1.3% q-o-q, 3.9% y-o-y to trigger a December rate hike.
In addition, a high-side labour force report might also be needed with October employment growth higher than expected (around 18,000) and the unemployment rate staying at 3.6% or pushing lower. The RBA’s end-2023 forecast unemployment rate is 3.8%.
Stronger-than-expected wage and labour force reports are possible but unlikely given the signs of a softer turn in labour market strength over the past month or two, mostly weakening job vacancies.
Even if the Q3 wage price index and October labour force reports come in close to expectations or softer a December rate hike could still be on the table if the monthly (October) CPI comes in too high. A too high October CPI would be a result that makes it unlikely that the RBA’s upwardly revised 4.5% end 2023 inflation forecast cannot be achieved.
The most recent annual CPI inflation readings of 5.4% for the Q3 CPI and 5.6% for the September month CPI mean that the October CPI will need to be 5.0% or less to make 4.5% at year-end possible. Falling petrol prices through October provide some chance of inflation decelerating sharply.
On balance, close to expectation wage, labour market and inflation reports in the second half of November are just enough we think for the RBA to pause in early December. However, the likelihood is not high in our view of soft data relating to inflation persisting beyond through the RBA’s summer break to the early-February policy meeting.
At least two factors lead to less progress reducing inflation than the RBA is forecasting in its latest forecasts. The first is government spending is high on cost-of-living measures and infrastructure projects. Whatever the benefits in terms of immediate reduction in cost-of-living pain or helping to improve productivity over time, they keep demand in the economy higher than would otherwise be the case, and inflation pressure higher than would otherwise be the case. There is no sign that Australian governments are looking at less cost-of-living relief and reduction in infrastructure spending is contingent on lengthy inquiry and review processes.
A second key factor is high immigration, keeping demand in the economy higher and notably demand in critically short-supplied housing. Housing costs are set to continue to inflate at double the top-end of the RBA’s 2-3% general inflation target for at least the next year.
Other factors include a much larger cohort of older superannuants in the current cycle benefitting from higher interest rates and spending more freely as well as the inflation cost now starting to show from Australia’s longstanding high concentration levels in key industries such as finance and grocery provision that are prohibited in many countries overseas by much tougher competition laws.
All these factors make it more likely than not that demand, and inflation will stay stickier than expected and lift the risk that high-side data reports related to inflation will pop up occasionally over the next few months. In short, the RBA’s revised inflation forecasts sit on the cusp of making it necessary to hike the cash rate again. That may not occur in December if key data reports between now and the next meeting come in around expectations, but the risk of upside surprises over the next two months is high and we expect the next 25bps rate hike to 4.60% to occur at the February 2024 RBA rate setting meeting.