TOL - 3rd Jul, 2023
High underlying inflation places pressure for a July rate hike
Underlying inflation remains uncomfortably high.
The monthly CPI showed underlying inflation remains uncomfortably high, tracking above the RBA’s forecast profile and placing pressure on the RBA to hike again in July, where its peers are confronting the same problem of it taking too long for inflation to return to target with much higher interest rates.
The ex-volatile items/transport CPI is a close proxy for the RBA's preferred measure of underlying inflation, which is the trimmed mean CPI.
This measure of underlying inflation picked up from 0.2% in April to 0.5% in May and has shown only a gradual improvement in trend terms this year.
On a rolling 3-month basis, annualised underlying inflation was 5.2% in May, which is down from a peak of about 8% last year, but it is not improving at the rate the RBA had forecast.
That is, interpolating the RBA’s forecasts for the quarterly trimmed CPI, they imply annualised growth should have been around 4.5% in May in trend terms.
This suggests that the RBA will likely nudge up its near-term forecasts for underlying inflation in the August Statement on Monetary Policy.
Uncomfortably high underlying inflation places pressure on the RBA to hike again in July, particularly given the RBA's belated concern about upside risks to inflation and where monetary policy is only slightly restrictive, with the RBA lagging its peers by a large margin.
That is, the RBA has belatedly become concerned about fast growth in unit labour costs, contrasting with the view it held last year that Australia could maintain lower interest rates than the rest of the world because of differences in our labour market.
Indeed, with the RBA recently raising its estimate of the neutral nominal cash rate from 3.5% to 3.8% - or from "at least 2.5%" in the case of Governor Lowe's view last year - the current cash rate of 4.1% suggests that monetary policy is only slightly restrictive.
This contrasts with the RBA's peers, where policy interest rates are much higher; for example, the US is at 5-5¼%, New Zealand is at 5½%, the UK is at 5%, and Canada is at 4¾%.
Higher interest rates are the product of other central banks confronting the same pressing problem of it taking too long for underlying inflation to return to target, particularly when service-sector inflation remains sticky and where there is uneasiness over whether high inflation will spill over to higher inflation expectations.
Less importantly, the monthly CPI also reported that the headline CPI was flat in the month (or down 0.4% in unadjusted terms), held down by a near-7% decline in petrol prices and a near-4% fall in travel costs on our seasonal adjustment.
Annual headline inflation slowed from 6.8% to 5.6%, which was much lower than the consensus market forecast of a 6.1% increase and below the RBA's forecast profile.
Note, though, that the volatility in headline inflation will continue, with massive price hikes for electricity slated for July.
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Based in Sydney, Kieran Davies is Chief Macro Strategist at Coolabah Capital Investments, an asset manager with 40 executives and over $8 billion in fixed-income strategies. Kieran is responsible for macroeconomic research and investment strategy, contributing to the investment decisions of the firm. Kieran has long experience as a macroeconomist in both the private and public sectors. He has worked most recently as Chief Markets Economist for National Australia Bank and was previously Chief Economist, Australia and New Zealand, for Barclays Bank and ABN Amro Bank/RBS. Kieran also worked as Principal Adviser on the macroeconomy and budget policy in the Commonwealth Treasury and Director of Forecasting.
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Based in Sydney, Kieran Davies is Chief Macro Strategist at Coolabah Capital Investments, an asset manager with 40 executives and over $8 billion in fixed-income strategies. Kieran is responsible for macroeconomic research and investment strategy,...
Based in Sydney, Kieran Davies is Chief Macro Strategist at Coolabah Capital Investments, an asset manager with 40 executives and over $8 billion in fixed-income strategies. Kieran is responsible for macroeconomic research and investment strategy,...
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