The RBA should hike in August
Underlying inflation is proving more persistent than the RBA had expected.
Underlying inflation continues to track above the RBA’s forecast profile, suggesting that the board should raise rates in August.
Headline inflation came in above market expectations for the third month in a row in May, up 4.1% over the past year.
More importantly, measures of underlying inflation - for which there are no consensus forecasts - point to persistent above-target inflation.
The monthly CPI proxy for the quarterly trimmed mean CPI - which is the RBA's preferred measure of underlying inflation - is the ex-volatile items/holiday travel CPI. This series rose by 0.3% in the month to be 4.1% higher than a year ago.
Similarly, annual trimmed mean inflation to 4.4% in May, its highest level since November (note that the ABS does not publish the monthly movement in the trimmed mean CPI, which is why it is approximated by the ex-volatile items/travel CPI).
The monthly proxy now points to the trimmed mean CPI increasing by 1.0-1.1% in Q2, with an assumption for the June outcome having little impact on the Q2 estimate (the Q2 result was previously estimated as a quarterly increase of 0.9-1.0% based on conservative assumptions for May and June).
Governor Bullock said in her recent press conference that the board had again considered raising rates in June, with policy-makers alert to higher-than-expected inflation in April and recent upward revisions to consumer spending.
If realised, a 1.0-1.1% increase in the trimmed mean CPI would be above the RBA’s 0.8% forecast, representing the third upside surprise to inflation in the past four quarters.
Politically a hike would be extremely difficult and it would also be presentationally awkward given a couple of the RBA's peers have started to cut rates and others plan to ease policy if inflation improves further.
However, it seems that underlying inflation is proving more persistent than the board had assumed, with the RBA failing to benefit from the persistent goods deflation seen in some other advanced economies and with services inflation still tracking in the 4s.
The governor understandably wants to avoid triggering a recession (or at least a negative quarter of GDP growth given the media frenzy that would ensue), but it still seems that policy is not tight enough to bring inflation back to the 2½% target by 2026, bringing home how her predecessor should have followed the example of other countries and raised rates sooner and by more in total.
The board might still decide to keep rates on hold, but that strategy would risk inflation staying high for longer, with the RBA not meeting the inflation half of its dual mandate.
Deputy Governor Hauser gives his first formal speech on the economy tomorrow night and might try to guide market expectations, although he may hold back if the governor does not want to publicly commit the board ahead of the Q2 CPI on 31 July and the policy meeting on 5-6 August.
For its part, the market now puts the odds of a rate rise in August at about 35%, up from around 10% yesterday.
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Based in Sydney, Kieran Davies is Chief Macro Strategist at Coolabah Capital Investments, an asset manager with 40 executives and over $8 billion in fixed-income strategies. Kieran is responsible for macroeconomic research and investment strategy, contributing to the investment decisions of the firm. Kieran has long experience as a macroeconomist in both the private and public sectors. He has worked most recently as Chief Markets Economist for National Australia Bank and was previously Chief Economist, Australia and New Zealand, for Barclays Bank and ABN Amro Bank/RBS. Kieran also worked as Principal Adviser on the macroeconomy and budget policy in the Commonwealth Treasury and Director of Forecasting.
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Based in Sydney, Kieran Davies is Chief Macro Strategist at Coolabah Capital Investments, an asset manager with 40 executives and over $8 billion in fixed-income strategies. Kieran is responsible for macroeconomic research and investment strategy,...
Based in Sydney, Kieran Davies is Chief Macro Strategist at Coolabah Capital Investments, an asset manager with 40 executives and over $8 billion in fixed-income strategies. Kieran is responsible for macroeconomic research and investment strategy,...
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