RBA: The answer is blowin’ in the wind

April 4, 2022

How many times must inflation surprise before central banks take a stand?

Like Bob Dylan, I was thinking that the answer must have been blowin’ in the wind.

The European March inflation figures released on Friday underscore the challenges facing the European Central Bank. At 7.5% they were almost a full percentage point above market expectations and the highest by far since the inception of the Euro.

The inflation challenge for the Fed is well known.

Like the Fed, the ECB now finds itself in the realm of already having made a policy mistake.

As Mohamed El-Erian noted in a recent piece for Bloomberg, a “first-best” solution looks beyond the Fed. The same goes for the ECB.

Instead, both central banks are engaged in the most delicate of central bank high-wire acts. Having let inflationary expectations escape the realm of being within their ability to comfortably manage without a serious risk of a substantial growth dislocation, both central banks are being forced to confront the question of the “least bad” approach.

In other words, choosing between meeting an inflation target by causing a recession, or allowing high and potentially destabilising inflation to persist well into 2023.

It seems likely that the RBA is to be issued its own challenge with the release on April 27th of the March quarter CPI inflation numbers.

The March quarter CPI may see the retirement of the notion that “Australia is different when it comes to inflation” (which was never wholly convincing) and with it, the existing RBA commitment to “patience” in raising the policy rate.

The potential challenge from inflation is illustrated by the latest forecasts from NAB economists of the March quarter CPI. NAB forecasts core (trimmed mean) inflation at a whopping 1.2% for the quarter and 3.4% over the year. If realised, the six-month annualised rate of core inflation would be 4.4%. Bear in mind, this is even before the full extent of the price pressures unleashed by the Ukraine conflict have been reflected.

An outcome close to the NAB prediction would blow the RBA’s February Quarterly Statement on Monetary Policy (SoMP) forecasts out of the water. Abstracting from any fuel excise cut, these numbers suggest that by mid-year core inflation will be well out of the 2-3% band at closer to 4.0% on an annual basis.

The March RBA Board Minutes suggested risks were “skewed to the upside” for wages and noted reports of firms being “increasingly prepared to pass these higher costs onto their customers.” In other words, inflation is not “transitory”.

The above scenario unambiguously intensifies the risks of waiting too long; being too “patient”.

The RBA must by now be keenly aware of this.

It must learn lessons from the starkly evident policy missteps of the Fed and ECB.

Expect maximum optionality in the Governor’s April Statement following the Board meeting on April 5th. This means retiring “patience” and foreshadowing a May rate rise.

Otherwise, the RBA might too find itself in the realm of “least bad” rather than “first-best” options, if it is not already there.

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

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