I’m riding on a midnight train
And everybody looks just the same
A subway light it’s dirty reflection
I’m lost babe I got no direction
The Saints – (I’m) Stranded, (1976)

As was universally anticipated, the Reserve Bank of Australia (RBA) Board left the policy rate unchanged when it met this week.

And while the Governor largely reiterated the “not ruling anything in or ruling anything out” messaging, there was just a hint of heightened anxiety regarding the “stickiness” of inflation.

Indeed, the Governor confirmed in her press conference that the case for a policy rate hike was discussed at the meeting but the case for a reduction was not. Further, she added that the Board needs “a lot to go its way” to get inflation back to target in a manner consistent with the RBA’s inflation projection.

Such sentiments are understandable.

Inflation remains stubbornly high. The April monthly consumer price index (CPI) indicator exhibited ongoing “stickiness”, as did the price and labour cost indicators contained in the most recent NAB May Monthly Business Survey.

The Board noted “although growth in unit labour costs has eased, it remains high [and] [p]roductivity growth needs to pick up in a sustained way if inflation is to continue to decline”, and further that “[w]ages growth appears to have peaked but is still above the level that can be sustained given trend productivity growth.”

All this suggests that the Board is particularly attuned to the upside risk to the May RBA CPI inflation projection.

While noting that “[c]onditions in the labour market eased further over the past month”, the Board added that conditions “remain tighter than is consistent with sustained full employment and inflation at target.”

But there is a suggestion that the labour market is fragile given weak activity indicators as evidenced by an articulation of the risk that “household consumption picks up more slowly than expected, resulting in continued subdued output growth and a noticeable deterioration in the labour market”.

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

Appropriately, the Board’s Statement and the Governor’s press conference emphasised the manifest uncertainties that it faces in determining the appropriate stance of policy.

Given current circumstances it is difficult for the RBA (or indeed central banks in general) to credibly supply financial markets with the certainties they crave.

Some of that uncertainty can be sheeted home to the unique nature of any recovery following from the pandemic.

That was part of an inflation shock that was compounded by the Russia / Ukraine conflict, Middle-East tensions and other geo-political risks (US and European elections included).

The task of central banks has also been frustrated by counter-productive government policies. Expansionary US fiscal policy following on from the curiously named Inflation Reduction Act is the most egregious example.

In the Australian context, the arrangements attaching to wage-setting and industrial relations regulation have complicated the RBA task and the Future Made in Australia measures may well do so.

So, this inflation shock is more complicated, and central banks, including the RBA need to “feel” their way through it.

The Governor has described the balancing of returning inflation to target and consolidating gains in the labour market (or avoiding recession) as akin to the negotiation of a “narrow path”. (Perhaps tightrope walking might be a more fitting metaphor.)

My best guess – and it is just a guess – is that a further hike is unlikely given the likelihood that underlying weakness in activity growth will show through in a weaker labour market and allow a more confident projection of inflation declining toward target.

Having said that, if there is a near-term adjustment in policy it is likely to be an upward move in the policy rate as a consequence of a further upside surprise in the June quarter inflation number. If that number were to significantly exceed the RBA’s (upwardly revised) trimmed-mean consumer price index (CPI) inflation forecast of 3.8 per cent then the August 5-6th RBA Board meeting may well have to consider increasing the policy rate further given its previously expressed “limited tolerance for inflation returning to target later than 2026”.

Were the June quarter CPI to be at or only trivially above the RBA projection, the most likely scenario is an extended pause in any policy rate adjustment until the RBA is convinced that its current trajectory for the return of inflation to target is secure. That argues for a policy rate cut sometime in the first half of 2025.

In the meantime, the policy rate remains stranded at 4.35 per cent.

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