The RBA is on hold until inflation falls further. A scenario necessitating a rate hike is not impossible, but it is unlikely, and it would only take shape later in the year.
With the inflation surprise in the March quarter and some further upside possible in the June quarter, the outlook for rate cuts in Australia has been pushed out. The timing of expected rate cuts in the United States has also been pushed out.
One body of opinion goes further, though, holding that rate hikes are necessary and likely in Australia. The reasoning seems to be that, because the RBA raised rates less than the Federal Reserve, it has (by definition) not done enough and will therefore end up having to do more. The unstated presumption behind this reasoning is that both countries face the same shock and the same context, and therefore the appropriate stance of policy is the same (and produced by the same level of the policy rate). Another unstated assumption in this line of argument is that the feasible rate of unemployment is well described by past averages or minimums, and therefore current rates are too low.
In our view, these presumptions are unjustified. As we have noted in the past, the United States is something of an outlier among peer economies. Domestic demand growth is outstripping that in peer economies; headline inflation is stabilising not still falling; and consumption per capita consistently rising. Both countries have tight labour markets, but our assessment is that next year will see labour market slack emerge in Australia.
More broadly, the two countries are facing very different fiscal contexts, which helps explain why domestic demand growth remains strong in the United States and weak in Australia.
This different fiscal context is in part shaped by the actual and perceived interest-sensitivity of the Australian household sector. Nowhere else in the advanced world is the discourse so aghast at the idea that fiscal policy might add to demand, thereby slowing the hoped-for disinflation and delay (or even reverse) the hoped-for rate cuts. Likewise, nowhere else in the world is the fiscal policymaker so incentivised to avoid a further rate hike.
Recall that while tax cuts are coming, these mostly give back recent bracket creep and are necessary to achieve even the small improvement in growth we expect over the second half of this year. They are also already in everyone’s forecasts. So they cannot be used as a reason to hike rates unless and until evidence emerges that the consumption (and so inflation) response to the tax cuts is larger than anticipated. That evidence, if it were to emerge, will not do so until late this year or early next year. In the here and now, retail spending and consumption more broadly are weak, and consumer sentiment remains extremely subdued.
A reasonable counter to this view is that the state governments are adding to demand. There are also longer-term issues around the structural budget balance. That is a separate issue from macroeconomic management over the cycle, though. State governments are in any case showing themselves to be sensitive to the need to be seen not to add to measured inflation. This week’s announcement by the Queensland government of an increase to electricity rebates is a case in point. Actual electricity bills will be lower, and so measured CPI inflation will be slightly lower, in the second half of the year as a result of that announcement.
Another line of argument for a rate hike hangs off the surprise in the March quarter inflation and labour force data. And maybe that argument is compelling to some of the decision-makers in Chifley Square. The nagging doubt around that course of action is that this was what happened last November, only to see a significant downside surprise in the December quarter inflation and real-side data. The result was that the RBA’s February 2024 forecast for trimmed mean inflation over 2025 reversed the upward revision in the November 2023 forecast round. Past surprises are most relevant for what they say about the future. There is no point warning that the disinflation journey could be bumpy if you then treat every bump as a change in trend.
There is a state of the world in which the RBA would need to raise rates. Consider a scenario where services inflation fails to decline further, the federal Budget later this month is more expansionary than expected, and the Fair Work Commission hands down a decision for an increase in the minimum wage not much below last year’s outsized result, even though inflation is much lower one year on. None of these outcomes seem likely given the atmospherics, but it is understandable that policymakers might want to see the actual results, and a bit more progress on inflation, before even thinking about cutting rates.
Could they hike? Not yet, and probably not given the current run of data. The language following next week’s meeting could be more hawkish. In the end, though, the Board will and should remain forward looking. We continue to expect the next move to be a cut, down the track.
