The RBA to narrowly vote to hike rates in September given high inflation

The RBA seems likely to narrowly vote to raise rates in September, barring surprise results for either Q2 GDP or August unemployment. Still-high inflation has picked up, even allowing for possible residual seasonality in the numbers, and is tracking above the RBA’s forecast profile. The RBA is closely watching the downturn under way in the housing market, but seems more concerned about the AI boom, where we estimate that tech prices have swung from subtracting from inflation to adding to inflation.  

The RBA board next meets on 28-29 September and seems likely to narrowly vote to raise the cash rate by another 25bp given still-high inflation is tracking above its forecast profile, barring a major surprise from either Q2 GDP or the August unemployment rate.

Core inflation has been stuck above the RBA’s 2½% target for about five years now, with annual trimmed mean inflation currently running at 3.6%.

Importantly for the RBA, inflation looks to have picked up and is running above the staff’s forecast that the quarterly trimmed mean CPI would post another 0.8% increase in Q3.

The monthly trimmed mean CPI rose at a much faster rate in July, increasing by 0.5% after rising by 0.3% in June. CCI’s nowcast based on the July numbers is for the trimmed mean CPI to increase by fractionally more than 1% in Q3, higher than the staff estimate of 0.8%.

Nowcasts based on only one month of the quarter are necessarily imprecise, although actual inflation – as measured by the 3-month moving average inflation rate, calculated using rolling weights – has also picked up, increasing from 0.8% in June to 0.9% in July.

We are also mindful that the increase in inflation in July could be overstated by residual seasonality in the numbers, such that earlier published gains were understated. This possibility arises because some prices included in the monthly CPI have too short a history for them to be seasonally adjusted by the ABS using traditional techniques.

CCI’s simple seasonal re-analysis of the figures suggests that the trimmed mean CPI picked up in July to 0.4% rather than the published increase of 0.5%, with earlier gains revised up. However, the re-analysis still suggests that inflation is tracking above the RBA's forecast of 0.8% for Q3, with 3-month moving average growth increasing to 0.95% in July.

For its part, a narrow majority of RBA policymakers are worried about upside risks to inflation, with the minutes of the August board meeting noting, “Several members judged that it was quite possible that the upside risks to the inflation forecast would crystallise, requiring some further tightening [of policy, while] other members noted the potential for downside risks to offset them”.

The board wanted to wait for more information before deciding on rates in September, with the minutes adding, “inflationary pressures might turn out somewhat stronger than [the] central case if some of the upside risks crystallised … [although there was] time to leave monetary policy unchanged while assessing [the] incoming data, … [where] members noted that, by the following meeting, they would have received additional monthly reports on inflation and the labour market and the June quarter national accounts, [and] additional information about … the housing market and the … conflict in the Middle East”.

Oddly enough, given this preference for waiting for more information, the board has not bumped the September board meeting to early October given the August CPI is published the day after the decision on interest rates.

For our part, simple policy rules have pointed to further policy tightening for some time given that inflation is above the 2½% target, the labour market is tight in that the unemployment rate is below estimated NAIRU, and policy is not particularly tight when judged using the neutral cash rate.

The obvious growing risk to this view has been that the downturn under way in the housing market could take the place of further policy tightening, depending on the impact on the broader economy. The housing market was rolling over before the RBA started raising rates and the government’s tax changes should accelerate the decline in house prices.

The board is watching the downturn closely, but does not seem fazed at this point given consumers are yet to curb their spending and a record number of homes under construction – about 1½ times the number of homes normally built in a year – could act as a buffer to reduced demand to build new homes.

Instead, in addition to the ongoing risks stemming from the Iran war, the board seems more concerned about risks related to the AI-driven boom in investment, both here and abroad, with AI mentioned several times in the board’s discussion after not coming up at all in the previous set of minutes.

The AI boom in business investment does not provide much of a boost to GDP because the related equipment is imported, but CCI estimates that more costly tech goods are now adding about 0.1-0.2pp to annual core inflation after consistently subtracting about 0.2-0.5pp from annual inflation over recent decades.

The construction of the data centres is also likely to raise the cost of building new homes – which has the largest weight in the CPI – by drawing away tradespeople and adding to the price of materials.