RBA: hawkish eye?

As was largely expected, the Reserve Bank of Australia (RBA) Board decided to leave the policy rate unchanged at 4.35 per cent.

However, the Governor confirmed in her press conference that the option of a policy rate rise was on the table at this week’s meeting.

It appears too that the Bank has gone from something close to a neutral bias to something resembling a tightening bias, albeit that move was of an incremental, almost grudging, nature.

The key phrase in the Governor’s Statement that indicates a soft tightening bias is one that affirms that the “Board expects that it will be some time yet before inflation is sustainably in the target range and will remain vigilant to upside risks.”

This would imply that the RBA Board believes that the prospect for any policy rate reduction in 2024 are at this stage remote.

I would expect the Governor to make this bias clear at her press conference. In particular, I would expect her to present as especially vigilant to “last mile” barriers to inflation returning to target.

Given developments since the Bank last met that should not be a surprise.

The March quarter consumer price index (CPI) report indicated inflation tracking above the projection outlined in the RBA February forecasts.

In addition, recent labour force reports suggest a slightly more resilient labour market than February forecasts.

I suspect that the reason that the RBA Board decided to eschew the option of a policy rate hike was a view that recent tepid activity growth, driven in particular by weak household spending (viz; today’s Q1 retail sales), would ultimately be reflected in a softening labour market and eventually in declining inflation.

Today’s Statement referenced “particularly weak” household consumption and added “there is a risk that household consumption picks up more slowly than expected, resulting in continued subdued output growth and a noticeable deterioration in the labour market.” (My emphasis.)

That goes to the heart of the RBA’s dual mandate of inflation at target and minimising unemployment.

But the patience of the RBA Board is clearly being tested.

I have previously expressed a view that monetary tightening is in indefinite abeyance and the next move in the policy rate is a cut. I still hold that view in anticipation of softer labour markets in the wake of weak activity growth, but the conviction levels attaching to that view are weak.

The “narrow path” cited by the previous Governor – when referring to balancing the risks between the vanquishing of inflation and minimising any excessive activity and employment dislocation – looks precariously thin.

Near-term indicators of inflation are critical.

Should these reveal that the “stickiness” in inflation continued into the current quarter it may be that a further increase in the policy rate becomes a necessity.

Next week’s Federal Government Budget is also a key hurdle, even if the Governor will be diplomatic about that in public.

Part of the reason behind “sticky” inflation in the US is that fiscal policy has worked against monetary policy.

That has not operated to the same degree in Australia, despite some ill-discipline at the state government level.

But the Federal Government’s fiscal resolve looks to be under some pressure.

The Future Made in Australia (FMA) measures recently announced by Prime Minister Albanese are a structural impediment to declining inflation.

Against the backdrop of changes to industrial relations and wage-setting arrangements, the FMA measures may inhibit the flexibility and dynamism of the economy.

That will limit potential long-term activity growth and see an accompanying increase in the non-accelerating inflation rate of unemployment (NAIRU), implying less favourable terms in the future for the trade-off between inflation and unemployment.

That will make it harder for the RBA to contain future inflation shocks without causing a larger increase in the unemployment rate. 

At this point, these are more “slow burn” type issues that are likely to be subsumed by cyclical developments, particularly if current tepid activity growth intensifies. However, their “unintended” negative consequences will grow in importance with the passage of time.

That is not unimportant given that inflation remains a clear and present challenge and the government would like interest rates on a downward path well before the next scheduled election.

But the reality is that those of us who were not long ago anticipating a policy rate reduction this year (like this writer) may have to cool their heels for a while yet.

So might a government that heretofore had been anticipating a pre-election policy rate decline. 

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