On the other hand | The RBA: ‘pause and reflect’ despite a particular inflation proclivity

I had canvassed the possibility that the RBA might ‘pause and reflect’ at the last RBA Monetary Policy Board (MPB) meeting that concluded on May 5.

That was not intended as a prescriptive statement but more as a descriptive sense of what the RBA may deliver. In particular, I was persuaded by the closeness of the (5-4) vote for an increase at the March meeting.

In any case, the RBA did increase the policy right, and for what it is worth, I think the RBA MPB probably made the right call. Inflation was already both too high and broad-based ahead of the Iran shock, even if the March quarter CPI outcome was slightly less than feared.

Furthermore, RBA forecasts issued at the time of the May meeting revealed a path for trimmed-mean inflation significantly higher than forecast back in February. To have eschewed a policy increase while forecasting a significant increase in inflation would have presented challenging optics.

But having raised the policy rate at three consecutive meetings – and at the risk of appearing to double down – I think there is scope for the RBA MPB to now ‘pause and reflect’.

And I mean that in a prescriptive way.

Yesterday’s March quarter GDP report indicated only modest growth, and even that was narrowly based, with investment in data centres accounting for all growth in the quarter and about one third of the 2.5 per cent growth over the year.

The latest April Labour Force report seemed to indicate a softer labour market with the unemployment rate increasing from 4.3 per cent to 4.5 per cent, even if there is some suggestion that the Australian Bureau of Statistics data may not have fully captured all seasonal effects, and hours-worked data remains strong.

However, some further action may be required in the second half of the year, particularly as governments continue to avert their eyes from any policy measures that might ease structural inhibitions to inflation containment.

In many instances, this involves ‘unintended consequences’ of regulatory creep in labour and goods markets. The failure to address those structural inhibitions has imparted a particular inflation proclivity in the Australian economy.

This week’s Fair Work Commission (FWC) decision on the minimum wage and awards is the latest example of attributes of the Australian labour market regulatory framework that impart that specific inflation proclivity. In saying that, I’m not suggesting that the FWC decision will, in and of itself, imply any significant automatic upward revision of RBA trimmed-mean inflation forecasts. But the decision makes a tricky inflation outlook all the more difficult to manage.

Even if yesterday’s GDP data indicated some moderating growth in unit labour costs at a little over 3 per cent annually (from the 5 per cent or more some 6 months previously), that is still difficult to reconcile with a seamless return of inflation to the middle of the 2-3 per cent target band.

Further, the decision may have the further ‘unintended consequence’ of more broad-based headwinds in labour markets as businesses are forced to seek savings in the wake of accelerating labour costs.

In any case, as stated earlier, three consecutive policy rate increases afford some room for the RBA MPB Board to ‘pause and reflect’ in June. But Australia’s particular inflation proclivity may still mean that the RBA might still need to reload later in the year.

The Fed: nothing doing…for now

Kevin Warsh presides over his first Federal Open Market Committee (FOMC) meeting as Chair in a little under two weeks. At this stage, it is difficult to construct a case that the Federal Reserve should do anything other than leave the current policy (federal funds) target rate of 3.50-3.75 per cent unchanged.

Indeed, financial markets are pricing with near certainty that exact outcome.

What is potentially a little more contestable is whether the Fed may adjust rates at some stage in 2026 and in which direction.

According to the RateProbability website, markets are seeing a probability of around 80 per cent that the Fed will increase the policy rate this year.

The Fed (like other central banks) is indeed challenged by the surge in oil prices in the wake of the Iranian conflict. And what has traditionally been the Fed’s favoured inflation measure, the core private consumption expenditures (PCE) price index, is well north of the Fed’s 2 per cent target. The April reading at 3.3 per cent was the highest since November 2023.

In that context, the market’s judgement of a rate increase looks understandable, particularly as labour market conditions, according to most indicators, remain in a satisfactory and stable condition.

Of course, the closely watched Bureau of Labour Statistics’ May non-farm payrolls report is released on Friday, and at this stage, markets are anticipating that report to show a continuation of that circumstance.

Certainly, this week’s April Job Openings and Labor Market (JOLTs) and the May ADP report give little cause for alarm on the labour market. The May ADP report showed a solid 122k gain. The ADP report is sometimes dismissed (too easily in my view) because of its poor record in foreshadowing month-to-month movements in the Bureau of Labor Statistics payrolls measure. However, it is just as good a measure of the state of the labour market as the payrolls report.

However, a potentially important consideration is that the new Fed Chair differs from his predecessor in placing some emphasis on US economic attributes that he believes may well make room for lower policy rates. Specifically, Warsh conjectures that disinflation in the US will follow from tremendous (largely AI-motivated) investment. In Warsh’s view, that investment has wrought a productivity dividend that (other things equal) has raised the US economy’s “speed limit”. In other words, the US economy can grow at a faster rate before igniting inflationary pressures.

That is a credible – if eminently debatable – position.

Certainly, what the US has going for it is that the surge in productivity is a structural disinflationary force not visible elsewhere, including in Australia. Over the last 4 years, US productivity growth has averaged a little over 2 per cent per annum. The equivalent Australian figure is -1.3 per cent. To put it more starkly, US productivity has grown by around 8 per cent in that time; Australia’s productivity has fallen by a little over 5 per cent.

That arguably puts the Fed in a better position than, say, the RBA to ‘look through’ any inflation impact from oil prices.

What is more, when it comes to inflation measures, Warsh has indicated that he prefers the Dallas Fed trimmed-mean measure of the PCE. That measure indicates a markedly different inflation trend from that suggested by the core PCE (see attached chart).

That measure was 2.3 per cent in April and indeed, has been around that mark since February. That is the lowest rate of increase in this measure since August 2021 and occurs despite broad-based price pressures emanating from the Trump tariff agenda.

If that remains the case – an admittedly big “if” – and if Chairman Warsh can convince other FOMC members of the veracity of his viewpoint, then rather than an increase, the door is ever so slightly ajar for policy interest rate reductions in the US at some stage in 2026.

Other central banks

ECB

The ECB meets next week and is almost certain to raise the policy (deposit facility) rate from 2 per cent to 2.25 per cent. Tuesday’s release of Eurozone CPI saw headline CPI broadly as expected at 3.2 per cent, but a higher than anticipated core rate (2.5 per cent versus 2.4 per cent expected and 2.2 per cent in April) and a significant acceleration in services inflation to 3.5 per cent in May from 3.0 per cent in April have markets pricing with near certainty a 25 bp increase at next Thursday’s meeting.

Bank of Canada

The Bank of Canada also meets next Thursday. With the trimmed mean and median inflation rates at 2.0 per cent and 2.1 per cent in April (compared with a 2 per cent target) and with fragile economic activity, the Bank is widely expected to leave the policy rate unchanged at 2.25 per cent.

Bank of England

The Bank of England meets on June 18. The most recent inflation report was better than feared: headline CPI in April declined to 2.8 per cent (versus 3.0 per cent expected) following 3.0 per cent in March. Core inflation came in at 2.5 per cent, down from 3.1per cent in March, and a little below the 2.6 per cent expected. Services inflation fell sharply to 3.2per cent (the equal lowest since October 2022) and also below the consensus forecast of 3.5 per cent. While inflation remains well north of the 2 per cent target, the decline in key inflation measures seems sufficient enough to forestall any potential increase in the policy rate at that June 18 meeting.

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