On track for a Feb RBA rate hike and a likely follow-up in May
Strong inflation continues to run above the RBA's forecast profile.
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The RBA looks on track to raise rates by 25bp in
February and likely follow up with another hike in May.
As foreshadowed by the monthly CPI, the RBA’s preferred measure of underlying prices – the trimmed mean CPI – rose by 0.9% in Q4 after a 1.0% increase in Q3. The strong increase plus some small revisions to history saw annual inflation round up to 3.4% in Q4.
Although not as disastrous a result as the Q3 outcome, the quarterly increase was above the RBA staff’s quarterly forecast of 0.8%, with annual inflation of 3.4% materially higher than the RBA estimate of 3.2%.
The RBA sometimes calculates the trend in inflation as the annualised inflation rate over two quarters, with this measure picking up from 3.4% in Q3 to 3.9% in Q4. Excluding the pandemic and its aftermath, this is the highest annualised rate over two quarters since the global financial crisis.
The detail of the CPI was also unwelcome news for the RBA, with housing costs and market services prices both rising strongly in Q4.
Housing costs are important because they have the largest weight in the basket of goods and services that make up the CPI.
The price of a new home, excluding land – which is the largest single component of the CPI –has recovered strongly from some small falls around the start of last year, rising more quickly in Q4, up 1.4% in the quarter to be 2.5% higher than a year ago.
Rents, which are the second-largest component of the CPI, posted another strong rise, increasing by 1% in the quarter to be up 4% over the past year (note that rents were distorted in earlier quarters by government subsidies).
Market services are services for which pricing tends to be market-based, with prices generally driven by domestic factors, especially labour costs.
Consistent with the strength in trimmed mean inflation, market services prices rose by an estimated 1.1% in Q4 to be 3.3% higher than a year ago.
The only moderately good news for the RBA was that the monthly trimmed mean CPI rose more slowly in December, up 0.2% after increasing by 0.3% for four months in a row.
However, a simple extrapolation of this smaller monthly increase would still see annual inflation track above the RBA’s forecast profile in the first half of this year, running closer to 3½% than the RBA estimate of 3.2%.
The RBA staff will finalise their forecasts this week for the RBA board to consider at their policy meeting next week.
Given the persistence in inflation and a better labour market than the RBA had anticipated, we still think that the RBA will hike rates by 25bp, lifting the cash rate from 3.6% to 3.85%.
The RBA rarely hikes rates once and a message of fine-tuning with only one rate rise would risk undermining the impact of tighter policy, such that a follow-up hike in May seems likely, where the Q1 CPI is due in late April.
The obvious risk to this view is that enough board members vote in favour of waiting for more information, particularly when the government will likely pressure the RBA not to hike.
Importantly, the persistence in inflation also suggests that the RBA needs to reconsider whether it has been wrong to override staff estimates with lower judgement-based assumptions for the NAIRU and neutral policy rate.
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Based in Sydney, Kieran Davies is Chief Macro Strategist at Coolabah Capital Investments, an asset manager with 65 executives and over $20 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 65 executives and over $20 billion in fixed-income strategies. Kieran is responsible for macroeconomic research and investment...
Based in Sydney, Kieran Davies is Chief Macro Strategist at Coolabah Capital Investments, an asset manager with 65 executives and over $20 billion in fixed-income strategies. Kieran is responsible for macroeconomic research and investment...
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