LPW Lowdown: When Will the RBA cut Rates?
Headline inflation, on both a quarterly and monthly basis, is well within the Reserve Bank of Australia’s 2-3% target band. Unemployment has ticked up as new arrivals and a moderation in economic activity alleviate labour shortages. Still, the RBA has refused to budge on interest rates. We detail three reasons why and what the central bank needs to see before it begins lowering the cash rate.
1. Beware Headlines
The old adage “Don’t judge a book by its cover” is particularly pertinent to the RBA’s reluctance to cut rates. The headline number is within the band, but the bank’s preferred trimmed mean measure remains stubbornly high at 3.5%, largely due to government concessions. The New Energy Relief Fund ($300 electricity bill rebate) has reduced prices by 17.3% in the September quarter and 15.8% in the past 12 months.
Data Source: RBA
Moreover, state-level concessions and lower petrol prices are also masking cost pressures bubbling under the surface. The RBA is acutely aware annual cost growth in categories such as Fruit and Vegetables (+8.6%), Health (+4.8%) and Insurance (+6.2%) remain elevated, and importantly are all big line items for household budgets. The RBA is unwilling to let the inflation genie out of the bottle (again) and therefore is waiting for cost pressures to abate.
2. Persistent Services Inflation
Another bifurcation in the numbers occurs between the price of goods and the price of services. Services inflation did not initially rise as quickly as goods during the pandemic, likely because services were less exposed to economic shocks, such as the conflict in Europe and pandemic-induced supply chain shortages.
Data Source: RBA
In a simple example, a law firm (service) isn’t particularly worried about shipping rates, whereas a retailer selling clothes (goods) is. Goods companies raise prices to protect margins, beginning the inflation cycle. As goods become more expensive, employee’s wages buy them less and real incomes fall. The law firm raises prices to compensate, with the cycle repeating until inflation is firmly stamped out, in a literal sense but also in the expectations of consumers. The view from the RBA is that services inflation needs to be controlled before interest rates can be eased.
3. Resilient Labour Market
The labour market has certainly cooled, but the central bank will argue there is still room for a reduction in employment. The participation rate (number of working-age Australians employed) remains at an all-time high. Underutilisation and underemployment are also low.
Interestingly, productivity has also fallen implying that output is not keeping pace with the addition of new employees. The RBA needs to see a pick up in output among the workforce, or risk entrenching inflation further and sluggish economic growth.
Cover photo source: Nikki Short, The Australian
