The Fed and the RBA part company on policy

Underlying inflation remained low in the US in July, matching market expectations and consistent with the Fed cutting rates when it updates its outlook next month.  

The Fed will probably opt for a 25bp cut, but a 50bp reduction is possible if the US labour market weakens further in the next round of data. 

The labour market has recently become more important to the Fed given it hadn't expected much change in the unemployment rate over the next few years, and history shows that the increase in the unemployment rate to date could quickly accelerate. 

Cutting ahead of the presidential election would be presentationally awkward  for the Fed given candidate Trump's views on monetary policy, although Fed Chair Powell has been at pains to stress the independence of the central bank.  

As for inflation, the July CPI report was good news for policy-makers, showing a return to lower inflation after the unexpected spike earlier this year.  

The core CPI rose by 0.2% in July after a 0.1% increase in June, rounding up in both cases, with annual inflation easing further to 3.2%. The estimated trend in monthly annualised inflation slowed to 1½%, mainly reflecting the influence of last month’s near-zero result.

The improvement in the core CPI reflects ongoing weakness in core goods prices, which are still falling, as well as an encouraging improvement in services inflation, driven by non-housing costs. 

The trimmed mean CPI, which captures the distribution of price changes across the basket of goods and services that make up the CPI, echoed the improvement in the core CPI.  

Locally, the RBA remains in a different position to the Fed, with Governor Bullock and her senior management team testifying on policy before parliament tomorrow morning. 

The governor is likely to repeat her recent hawkish comments about inflation being too high, although the board's central case appears to be to hold rates steady for longer in order to return inflation to target.  

Politicians will likely quiz the governor on whether fiscal policy is frustrating the operation of monetary policy, although Bullock probably try to avoid saying anything blunt on the subject.  

Ahead of that testimony, today's labour market data are likely neutral for monetary policy.  

The unemployment rate edged up to 4.2%, up from a low of 3.5% last year and broadly in line with the RBA's forecast profile, which has unemployment peaking at 4.4% next year.  

Unusually, the rise in unemployment has been driven by the supply of labour outpacing  a still strong demand for workers (normally increasing unemployment reflects weaker demand in response to tight policy) .  

Job vacancies are still falling from their record high, but are yet to return to pre-COVID levels, while employment is growing strongly and total hours worked have rebounded over recent months, almost returning to their all-time high.  

The employment-population ratio is only a fraction below its recent record high and is unchanged from when the unemployment rate reached its low point last year.  

However, the supply of labour is still being propelled by record migration, with the working-age population growing at an annual rate of about 3% and the participation rate reaching a new all-time high.  

The rise in unemployment points to a slight loosening of the labour market, although conditions remain tight, in that unemployment is still below the 4¾% midpoint of the RBA's estimated range for the NAIRU.  

While there is uncertainty around any estimate of the NAIRU, the RBA is not forecasting the gap between the unemployment rate and the NAIRU will close over the next few years, which is why it expects it will take a long time for inflation to return to the 2½% midpoint of the target range.