The RBA Board is expected to leave the cash rate unchanged at next week’s meeting. The recent data-flow will provide some comfort that restrictive policy is bringing inflation back under control, but the path is still uncertain. Vigilance remains the order of the day until the RBA becomes more confident of achieving a sustained return to sub-3% inflation.
The Reserve Bank Board meets on June 17-18. We expect it to again leave the official cash rate unchanged, repeating the view that restrictive policy is bringing inflation back towards target but that uncertainty around the timeframe means it needs to remain vigilant to upside risks.
At its May meeting, the Board assessed that demand was coming back in to line with supply quite quickly. Updates since then have continued to support this ‘rebalancing’ view.
The most important update – and part of the rationale behind the RBA Board’s new meeting schedule – has been the March quarter national accounts. This provides a comprehensive view of the wider economy, including overall growth, the mix and strength of demand and some key metrics for gauging domestic cost pressures.
Growth all but stalled in the first quarter of 2024, annual GDP gains slowing to just 1.1%yr with weakness centred on the consumer. That result was in line with the RBA’s expectations, its forecasts from the May Statement on Monetary Policy having GDP growth slowing to 1.2%yr by the June quarter.
The detail did carry some surprises, particularly around the consumer, but the impact here looks to be mixed from the RBA’s perspective. Spending was a little firmer than expected in the quarter with significant upward revisions, relating to estimates of outbound tourism spending by Australians, lifting the growth profile over the last year. The combination of sharp rises in the cost of living, higher interest rates and surging tax payments is still weighing heavily but not quite as heavily as previously indicated, annual growth running at 1.3%yr rather than around flat.
Our view is that these changes have only limited implications for the RBA.
Firstly, they relate to history and so are already reflected in measured inflation.
Secondly, the revised spending profile means households have been saving much less, the implied run-down of buffers carried over from the pandemic meaning there is less scope to use these funds to sustain spending going forward (we estimate around 45% of this notional reserve has now been run down, compared to about 20% previously).
And lastly, the upward revisions centre on spending abroad and are therefore less relevant for assessing the extent to which demand is pushing up against supply constraints and contributing to domestic inflation pressures. If that demand starts getting redirected locally, it would be a different story but so far, this does not look to be the case (indeed both anecdotes from customers and recent reads from our Westpac Card Tracker suggest demand has weakened noticeably again in the June quarter).
The other detail from the March quarter national accounts update would have been broadly as hoped. In particular, productivity is continuing to show signs of improvement with productivity-adjusted measures of domestic labour costs also turning. Annual growth in nominal non-farm unit labour costs (the effective cost of labour once both wage costs and productivity are taken into account) slowed from 6.8%yr to 5.7%yr and has been tracking a 2.9% annualised pace over the last two quarters. The improvement in non-mining sectors has been particularly promising. This is broadly consistent with inflation in domestically-driven segments like the market services sector slowing to around a 3.5% annual pace.
Other developments over the last month would also be giving the RBA more comfort on this front. Wages growth is showing clearer signs of having peaked at just over 4%yr, with the Fair Work Commission’s decision to lift minimum wage and award rates by 3.75% this year – down from an average increase of 5.75% last year – supporting the view that growth will continue to cool (the RBA’s May forecasts has wage growth moderating to 3.4%yr in 2025).
The labour market more broadly is also showing a gradual moderation with a desirable mix from the RBA’s point of view. Employment growth has eased back to be in line with population growth, meaning participation and unemployment rates are holding about flat. However, there is clearer evidence of slack emerging around hours worked and underemployment – employers look to be responding to slower demand with adjustments in loading rather than headcount. That is the ideal mix for achieving a ‘soft landing’ that contains wage growth and inflation but avoids the additional damage associated with job losses.
The other major development since the RBA Board’s May meeting has been the Federal Budget. This is also likely to be broadly ‘a wash’ for policy although there may be some wrinkles around how various cost-of-living measures are expected to impact.
The combined effect of both Federal and state government cost-of-living measures will accentuate the decline in headline inflation over the second half of the year. We now expect annual inflation to drop into the RBA’s 2-3% target range, ending the year at 2.9%yr. Much of this will reverse as temporary energy bill relief rolls off, and there is some risk of spill-over effects to wider demand slowing the pace of disinflation elsewhere.
However, these risks seem low given the consumer frame of mind and are likely to be offset by the anchoring effects of lower headline CPI reads. Consumer sentiment remains very weak. Responses to specific questions on tax cuts also indicate that consumers are likely to put any ‘windfall’ income gains towards rebuilding depleted savings buffers rather than spending. Sub-3% headline inflation reads will also help anchor inflation expectations at lower levels both via perceptions and the impact on a range of prices and wages that are indexed to the CPI.
As always, there will be many other considerations for the RBA Board, but June’s meeting is likely to be framed in much the same way as May’s. That was in the context an upside surprise to inflation that saw the Board consider an additional rise but opt to leave rates unchanged and adopt a more vigilant approach to assessing further risks. Those risks are still primarily around the path of actual inflation, suggesting the Bank is unlikely to relax until we get more quarterly CPI updates.
As such, the last six weeks would have given the RBA some comfort that other aspects of the economy were evolving as expected or hoped, and that other upside risks were not materialising. But it will be looking for a bit more evidence around inflation before it can relax, let alone be confident enough about hitting its inflation target that it can start to shift its stance.
