Persistent inflation to test RBA’s patience

Australia's main inflation indicator - the annual rate of increase in the quarterly Consumer Price Index (CPI) - now has a three in front of it for the first time since 2021, after a fifth consecutive quarterly decline took the inflation rate down to 3.6 per cent in the March quarter of this year. But while the disinflation process continued last quarter, the pace of that disinflation disappointed.

Market forecasts had anticipated more progress, and with both the headline and underlying inflation prints surprising to the upside this week, including an acceleration in quarterly growth rates in both cases, financial markets reacted on Wednesday by pushing back the likely timing of a first RBA rate cut into next year.

Last week's relatively strong labour market report for March had already made a case for the central bank leaving rates higher for longer, so this week's market reaction is unsurprising. And while our view is that it is still too early to rule out a rate cut for the whole of 2024, we must concede that with this week's data highlighting persisting non-tradables and services inflation, Australia's central bank is now likely to be even more cautious before contemplating a first policy easing. Consequently, no interest rate relief now looks likely until November's meeting at the earliest.

What about the case for a rate hike? After all, following its last meeting, the RBA was still saying it was unable to rule out a future rate move in either direction. Absent adverse shocks, additional tightening seems unlikely. Martin Place has repeatedly demonstrated patience in its quest to return inflation to target as it seeks to minimise collateral damage to the labour market and the risk of recession. Unless something changes to force the Board's hand, sticking with the current contractionary setting of the cash rate still looks like the most appropriate way to maintain balance between those objectives. That said, if Q1:2024 inflation readings result in the RBA adjusting its inflation forecast materially upwards next month, that will involve an important test of the RBA's patience.

This inflation-monetary policy environment also has implications for next month's Federal Budget. Recent economic developments leave little room for the Government to do much to stimulate domestic demand beyond the adjustments already made to the Stage Three Tax cuts without unduly complicating the central bank's inflation-fighting task, and thereby risking triggering an offsetting interest rate adjustment.

With Budget 2024-25 approaching, a diary note about our Economic Policy and Budget Update 2024.

As usual, more detail below.

Inflation falls again in March quarter, but by less than expected

Australia's annual rate of Consumer Price Index (CPI) inflation eased to 3.6 per cent in the March quarter of this year, down from 4.1 per cent in the December quarter of 2023. While that marked a fifth consecutive decline in the headline inflation rate, the outcome was a bit higher than market expectations. The consensus forecast had anticipated a 3.5 per cent print this week, which would also have been in line with the outcome implied by the RBA's forecast profile (although the central bank only publishes outcomes for the June and December quarters).

Disappointingly, the first quarter of this year brought an acceleration in the quarterly rate of price increases. After rising by 0.6 per cent over Q4:2023, the CPI increased by one per cent over Q1:2024, running ahead of the market's median forecast of a 0.8 per cent rise.

In the case of underlying inflation, quarter-on-quarter growth in the trimmed mean measure picked up to one per cent last quarter from 0.8 per cent in the preceding one, while the annual rate of increase edged down to four per cent from 4.2 per cent. Once again, this set of results was stronger than the market had expected, with the consensus forecast having predicted a 0.8 per cent quarterly rise and a 3.8 per cent annual one.

The ABS said the biggest drivers of the quarterly growth rate were Education (up 5.9 per cent quarter-on-quarter), Health (2.8 per cent), Housing (0.7 per cent) and Food and non-alcoholic beverages (0.9 per cent).

In the case of education, the Bureau noted that fees typically increase at the start of the calendar year (for example, this is when annual CPI indexation is applied to tertiary education fees, while primary and secondary school fees are also usually increased at this time). Even so, the March quarter 2024's 5.9 per cent rise was the largest recorded since 2012.

The ABS told a similar story about health, noting that prices for medical and hospital services typically rise in the March quarter as providers review their fees. At the same time, Medicare and PBS Safety Net thresholds also reset in the first quarter, meaning that fewer Australians qualify for subsidised prices.

In terms of housing, the Bureau highlighted the contributions of rents (up 2.1 per cent) and new dwellings purchased by owner-occupiers (up 1.1 per cent), with rents driven by low vacancy rates, while high labour and material costs push up construction prices.

Turning from quarterly to annual increases, the main contributors to the latter were Housing (up 4.9 per cent over the year), Food and non-alcoholic beverages (3.8 per cent) and Alcohol and tobacco (6.3 per cent).

The ABS again highlighted annual growth in rental prices, which were up 7.8 per cent over the year, recording their strongest rise since March 2009. Indeed, excluding the impact of Commonwealth Rent Assistance, they would have risen by an even larger 9.5 per cent. (It's also worth noting here that government interventions continue to influence the price profile elsewhere in the CPI basket, with electricity prices falling 1.7% over the quarter, reflecting the ongoing impact from the Energy Bill Relief Fund rebate.)

Other notable annual price rises recorded in Q1:2024 included increases in education fees, which rose at their fastest rate in 12 years, and in insurance prices, which soared 16.4 per cent over the year. The latter was the biggest increase since 2001 and reflects the impact of higher reinsurance, natural disasters, and claims costs on premiums for house, contents, and car insurance.

In terms of the analytical story behind the March quarter results, the tale was a largely familiar one, with ongoing rapid disinflation for goods and tradables offset by slower progress for services and non-tradables. So, for example, the annual rate of goods inflation eased to 3.1 per cent last quarter from 3.8 per cent in the previous quarter, marking a sixth consecutive quarterly decline for good inflation, which peaked at 9.6 per cent back in Q3:2022. Annual inflation for most goods eased in the March quarter with some items - including footwear, furniture, appliances, and meat and seafood products - experiencing outright deflation.

At the same time, while the annual rate of services inflation did ease for a third consecutive quarter - dropping to 4.3 per cent last quarter from 4.6 per cent in the preceding quarter and down from a peak of 6.3 per cent in the June quarter of last year - it remained elevated relative to the rate of goods price inflation.

Similarly, annual inflation for tradables slowed to just 0.9 per cent, down from 1.5 per cent in the previous quarter and a peak of 8.7 per cent in H2:2022, reflecting the goods price deflation noted above. On the other hand, annual inflation for non-tradables remained much higher at five per cent in Q1:2024, albeit down from 5.4 per cent in Q4:2023.

What does all this mean for the RBA and monetary policy? If the good news was a fifth consecutive quarter of lower annual inflation and of lower underlying inflation, the much less welcome news was that the RBA's repeatedly expressed concerns about persistent services and domestic inflationary pressures were clearly manifest in this week's data. That in turn means that - following several readings that seemed to imply the disinflation process in Australia was running slightly ahead of the RBA's expectations - the rate of disinflation is now lagging the RBA's latest set of projections. That shift could see the central bank nudge up its inflation forecasts when it releases the next Statement of Monetary Policy on 7 May. It also meant that financial markets' immediate response to this week's inflation data was to push back the likely timing of a first RBA rate cut into 2025.

We wouldn't be quite that conservative on the likely timing of a first move to ease policy and judge that there is still a decent chance of a rate cut this year. At the same time, this week's inflation numbers, together with last week's labour market report (discussed below) do argue for pushing back the timing of any such move. After the May Board meeting, remaining monetary policy meetings this year are scheduled for 17-18 June, 5-6 August, 23-24 September, 4-5 November and 9-10 December. Based on recent developments, any rate cut before the November meeting at the earliest now looks very unlikely.

Noted: the annual weight update of the CPI. There were increases in the weight for international holiday travel and accommodation (up 0.92 percentage points as Australians continue to holiday overseas), domestic holiday travel and accommodation (up 0.82 percentage points), rents (up 0.28 percentage points as vacancy rates remain at historic lows), for electricity (up 0.14 percentage points on the back of higher prices), for motor vehicles (up 0.43 percentage points) and automotive fuel (up 0.12 percentage points). There were falls for tobacco (down 0.57 percentage points as smoking rates continued to decline), new dwelling purchases (down 0.55 percentage points reflecting fewer dwelling commencements last year), furniture (down 0.22 percentage points due to lower discretionary spending) and for telecommunications and for audio, visual and computer equipment (both down 0.19 percentage points).

Monthly indicator of inflation increases in March 2024

While most attention was on the quarterly CPI readings this week, the ABS also published the monthly Consumer Price Index (CPI) Indicator for March 2024. The headline monthly inflation reading rose slightly to 3.5 per cent over the 12 months to March this year, up from 3.4 per cent in February. Likewise, the annual rate of increase for the CPI, excluding volatile items and holiday travel rose to 4.1 per cent from 3.9 per cent. Finally, the year-on-year increase in the Annual Trimmed Mean nudged up to four per cent last month from 3.9 per cent in February.

Unemployment rate ticks higher

Last Thursday, the ABS reported that Australia's unemployment rate rose to 3.8 per cent in March 2024 (seasonally adjusted), up from 3.7 per cent in February. The number of unemployed persons rose by 20,600. The underemployment rate fell to 6.5 per cent from 6.6 per cent over the same period, however, leaving the underutilisation rate unchanged at 10.3 per cent.

The ABS also said the number of people employed fell by 6,600 over the month, leaving aggregate employment almost flat at a bit below 14.3 million. Full-time employment rose by 27,900, but part-time employment dropped by 34,500.

The participation rate eased to 66.6 per cent, while the employment to population ratio also fell slightly to 64 per cent, leaving both ratios only a little below their recent record highs and well above their pre-pandemic levels.

Monthly hours worked in all jobs rose by 0.9 per cent or 17 million hours over the month.

The March labour market readings followed a surprisingly strong February 2024 result, driven by a larger-than-usual flow of people into employment following smaller-than-usual flows in December and January. As discussed earlier this month, the ABS has previously pointed to changes in the seasonal pattern of employment around the turn of the year as driving unusual volatility in recent labour market results. In order to adjust for this, if we switch focus from seasonally adjusted data to trend numbers, the latter suggest the unemployment rate has been unchanged at 3.9 per cent since November 2023, the underemployment rate has been steady at 6.6 per cent over the same five months and the underutilisation rate has hovered around 10.4 per cent.

In fact, with the March data, the Bureau reckons monthly employment flows have now 'returned to a more usual pattern.' But if so, what did this 'more usual pattern' tell us about the state of the labour market? The consensus forecast had anticipated an unemployment rate of 3.9 per cent and an increase in employment of 10,000 in March. So viewed in that context, actual results were slightly stronger in terms of the former and somewhat weaker in terms of the latter.

More generally, last month's numbers suggest that while labour market conditions have started to ease again, they nevertheless remain relatively tight overall, certainly compared to pre-pandemic conditions. For example, despite March's uptick, the unemployment rate is still below January's 4.1 per cent rate and has averaged around 3.9 per cent over the first quarter of this year. That's largely unchanged from the December quarter of last year, is only slightly higher than the 3.7 per cent average unemployment rate recorded in the September quarter 2023 and is not much higher than the low of 3.5 per cent reached in the December quarter 2022. It is still well below the 5.2 per cent average unemployment rate that applied to the final quarter of 2019.

Put slightly differently, there is nothing in this set of labour market numbers that will be shouting out to the RBA that monetary policy is too tight or that the labour market is in trouble (although it is important to keep in mind here that labour market conditions are typically a lagging, not leading, indicator of economic weakness). For some context, in its February 2024 forecasts, the RBA said it expects the unemployment rate to rise to 4.2 per cent in the June quarter and 4.3 per cent in the December quarter of this year.

Finally, note that in its recent communications (both in the February 2024 Statement on Monetary Policy and in the latest RBA Bulletin), the central bank has been at pains to stress that its assessment of 'full employment' does not rest on any single labour market indicator such as the unemployment rate, but rather rests on a 'wide range of inputs'.

IMF now thinks global growth will be steady over 2024-25

Last week's release of the latest forecasts from the IMF's World Economic Outlook (WEO) reveals that the fund's new baseline is for the world economy to grow at 3.2 per cent this year and next, broadly unchanged from the 2023 outcome. Advanced economic growth is forecast to rise gradually from 1.6 per cent last year to 1.7 per cent this year (mainly reflecting recovery in the Eurozone) and 1.8 per cent in 2025, while emerging market and developing economy growth is projected to dip slightly from 4.3 per cent last year to 4.2 per cent this year and then be unchanged next year.

Here in Australia, IMF projections have real GDP growth slowing from 2.1 per cent in 2023 to 1.5 per cent this year, before recovering to two per cent in 2025.

According to IMF Economic Counsellor Pierre-Olivier Gourinchas, the global economy has proven to have been remarkably resilient, combining steady growth with a decline in inflation that has been almost as rapid as its earlier increase. As a result, he argues, 'most indicators continue to point to a soft landing', with median headline inflation expected to decline from 2.8 per cent at the end of this year to 2.4 per cent by the end of next year, even as global growth holds steady. Credit for this resilience largely goes to favourable developments on the supply side, led by the fading of energy price shocks and with an important supporting role played by an immigration-led rebound in labour supply for many advanced economies.

The IMF sees risks to this baseline forecast as broadly balanced, with the tilt to downside risks in the April and October 2023 WEOs now having abated somewhat. According to the April 2024 WEO, the estimated probability that global growth will fall below two per cent - an outcome that has occurred only five times since 1970 - has fallen from 15 per cent at the time of the October 2023 WEO to about 10 per cent now.

Downside risks include the threat of new commodity price spikes amid regional conflicts (in particular, think the oil price and the Middle East); a slower-than-expected decline in core inflation and adverse consequences for interest rates, financial conditions, and asset prices; a faltering of China's economic recovery; disruptive fiscal adjustments and debt distress; an absence of economic reform due to low confidence in governments and institutions, sometimes amid political polarization; and an intensification of geoeconomic fragmentation. But now balancing these downside threats are the possibility of positive surprises for the global economy, including the potential for a short-term fiscal boost in response to the 'Great Election Year' that is 2024; additional positive supply-side surprises allowing for more rapid monetary policy easing; a lift to productivity due to artificial intelligence; and faster-than-expected implementation of structural reforms.

What else happened on the Australian data front this week?

The Judo Bank Flash Australia Composite PMI Output Index rose to 53.6 in April 2024 from 53.3 in March, hitting a 24-month high. Private sector business activity has now risen for a third consecutive month, expanding at the fastest rate since April 2022. The rise in the Composite PMI reflects a jump in the Flash Australia Manufacturing PMI Output Index, which hit an eight-month high of 49.1 in April, up from 45.7 in March. In contrast, the Flash Australia Services PMI Business Activity Index slipped to 54.2 this month from 54.4 last month, a two-month low. Still, note that services activity remains firmly in positive territory (that is, above an index reading of 50) while manufacturing output continues to contract, albeit only marginally this month. Judo Bank said the past three months of PMI readings taken overall were consistent with a cyclical recovery in the Australian economy in 2024, after last year's consumer-led slowdown.

At the same time, the PMI survey reported that input prices rose at a faster rate in April, with rising cost inflation in both the manufacturing and services sectors, partly due to higher raw material prices and the consequences of a weaker Australian dollar. Interestingly, businesses opted to partially absorb some of this pressure, with the rate of increase in selling prices easing for a second consecutive month.

The ANZ-Roy Morgan Index of Consumer Confidence fell 3.2 points to 80.3 index points in the week ending 21 April 2024. That marks the lowest reading for the weekly index recorded this year, with two subindices - future financial conditions (next 12 months) and short-term economic confidence (next 12 months) - also falling to their weakest readings this year, as well as recording the largest weekly declines seen since October 2023. Confidence about the medium-term economic outlook (next five years) also fell to its lowest reading of the current year. ANZ noted that confidence last week was down across all three housing cohorts (renters, mortgage-holders and outright owners) with renters suffering a particular large fall and those paying off a mortgage reporting their lowest level of confidence in 2024 to date. The index has now been below the 85 level for a record 64 weeks. Meanwhile, weekly inflation expectations fell 0.2 percentage points to five per cent.

Government Finance Statistics for the 2022-23 financial year show that the general government net operating balance improved by $73 billion, increasing from a deficit of $34.7 billion in 2021-22 to a surplus of $38.3 billion last year. General government net debt fell from 33.4 per cent of GDP to 30.6 per cent of GDP over the same period. See also this Insights into Government Finance Statistics article from the ABS for more detail on developments and an explanation of the concepts used.

The ABS released new data on Australia's population by country of birth. As of 30 June 2023, 8.2 million or 30.7 per cent of Australia's population were born overseas. That's the highest share since 1892, when it was 31.3 per cent. England (3.6 per cent of the estimated resident population), India (3.2 per cent), China (2.5 per cent) and New Zealand (2.2 per cent) are the largest source countries, collectively accounting for more than a third of Australians born overseas.

Other things to note . . .

• The April 2024 Edition of the RBA Bulletin includes essays on Assessing full employment in Australia, cash rate pass-through to mortgage rates, bank funding costs, urban residential construction and steel demand in China, and more.
• Peter Martin explains the value in reading the budget's fiscal strategy update.
• A summary of the latest Deloitte Access Economics Business Outlook, which reckons the Australian economy is in a holding pattern - activity is being supported by population growth, but geopolitical disruption and stalling homebuilding are generating headwinds.
• The Productivity Commission on merger reform.
• From last week's AFR, former Productivity Commission Chair Gary Banks argues that the current government's productivity agenda is in reality mainly a spending agenda, missing the kind of regulatory reforms needed to stimulate a stronger economic performance.
• ABC Business on how federal environmental laws are slowing investment in renewable energy. Related - state-level approvals are a problem too.
• The ABS looks back at more than 150 years of Australian agricultural commodity data including timelines for wheat and wool.
• From the IMF, the flagship Financial Stability Review analyses Fragilities along Disinflation's Last Mile while the Fiscal Monitor considers Fiscal Policy in the Great Election Year. There are also new regional outlooks for Europe, Sub-Saharan Africa, and the Middle East and Central Asia.
• What happened to the natural rate of interest after the pandemic?
• This column suggests a shift to a high-uncertainty regime during the pandemic and its aftermath may have led businesses to become more flexible in price-setting. Investment in price-setting flexibility could include moving into online sales, using IT to gauge demand and to monitor competitors' prices, introducing electronic price displays and adopting price escalation causes. One consequence of this shift is that firms become more resilient to adverse price shocks. At the same time, the greater responsiveness of producer prices also means higher inflation.
• The NY Fed on US export controls, geopolitical risk, and decoupling.
• Carnegie considers Russia's economic stability.
• The FT Big Read asks, Is South Korea's economic miracle over?
• A new World Bank Report on The Great Reversal examines the decline in development that took place over 2020-24 across many of the 75 economies that are eligible for the Bank's International Development Association (IDA) low-interest loans and grants. According to the report, one out of three IDA economies is now poorer than it was on the eve of the COVID-19 pandemic, while poverty remains high, and hunger has surged.
• A Brookings report proposing a set of ambitious reforms for a 21^st century global financial architecture including changes to the IMF and World Bank, debt relief, a Green Bank and a global carbon market, and a global tax regime.
• China, BYD and the Electric Vehicle Developmental State.
• Dani Rodrik says the US manufacturing renaissance will create few good jobs, due to trends in automation and skill-biased technological change.
• WSJ reckons giant asset management firms, not big banks, now rule Wall Street, with traditional and alternative asset managers controlling twice as many assets as US banks and supplanting the latter as lenders to US companies and consumers.
• FT Alphaville reads ex-UK PM Liz Truss's book and takes an interesting (chiropteran) angle.
• Annalee Newitz in the MIT Technology Review presents a brief, weird history of brainwashing.
• It's perhaps a little dated now (the episode was published on 15 March 2024), but this Intelligence Squared podcast with Martin Wolf on the global economic outlook is still worth a listen.
• The Past Present Future podcast has been discussing the History of Freedom. This is their episode on What is the Free Market? Always interesting if occasionally ever so slightly infuriating (at least for this economist, ymmv) to hear a philosophical take on markets and economics.
• The These Times podcast discusses the current tensions between Guyana and Venezuela and asks, is this the next oil war?