An uneasy feeling Jamie Lee Curtis

Like a heroine in a horror movie that suddenly feels that something is not quite right, the RBA Board is starting to feel a little uneasy. Sure inflation is still sticky, the labour market tight, and the economy slowing but the consumer is reducing their spending right? And surely there could be no more supply-side shocks? Could the RBA’s narrowing path be shrinking to the width of a glistening knife blade?   

What the RBA’s Statement said

“Inflation remains above target and is proving persistent.”

“Recent data revisions suggest that consumption over the past year was stronger than previously suggested.”

“While recent data have been mixed, they have reinforced the need to remain vigilant to upside risks to inflation.”

“The persistence of services price inflation is a key uncertainty.”

“Recent budget outcomes may also have an impact on demand, although federal and state energy rebates will temporarily reduce headline inflation.”

“Real disposable incomes have now stabilised and are expected to grow later in the year, assisted by lower inflation and tax cuts. There has also been an increase in wealth, driven by housing prices. Together, these factors are expected to support growth in consumption over the coming year.”

Statement by the Reserve Bank Board: Monetary Policy Decision, 18 June 2024.

https://www.rba.gov.au/media-releases/2024/mr-24-12.html

What the Governor said at the press conference

“We still think we are on the narrow path. It does appear to be getting narrower. We need a lot to go our way if we are going to bring inflation down to the 2% target range. The Board does need to be confident that inflation is moving sustainability toward target and it will do what is necessary to achieve that outcome.”

“They (the Board) wanted to make the point that they are alert to the upside risks. … just a few little alerts to suggest we might need to remain vigilant.”

“The June CPI is going to be an important one because it is going to give us a lot more comprehensive view of what is going on.”

“The case for a cut was not considered”

“Aggregate demand is still above aggregate supply and that’s what is keeping inflation a little bit high.”

The economy continues to slow

GDP grew just 0.1% in the March quarter compared to the December quarter. GDP per capita decreased for the fourth month in a row to continue what some commentators are calling a “GDP per capita recession”.

Looking under the hood of the 0.1% increase, we see that both public and private demand grew only slightly with growth mainly driven by an increase in inventories - typically a sign of lower future production (see chart below). Aggregate demand seems to be slowing as the RBA hopes and has been predicting.

GDP Revisions mean consumer spending was stronger than previously thought

Slowing GDP in the March quarter was no surprise but what did surprise was the upward revision to spending and the downward revision to the savings rate for the last several quarters. In particular, it turns out the consumers have been spending much more on overseas holidays than previously thought (see chart below).

The downward revision in the savings rate can either be explained by consumers more eager to spend than previously thought or by consumers reducing savings to meet increased living expenses. The RBA’s models suspect that most consumers are in the former category but Bullock is not certain. Consumer sentiment remains at pessimistic levels which suggests that more consumers may be in the latter category, unless many consumers are “doom spending”!

These revisions have caught the RBA Board’s attention. Just last month, Bullock was taking comfort in declining retail turnover. Now Bullock and the Board have to slightly reinterpret the last few quarters. Consumer spending is still slowing but not as much as previously thought. 

With real incomes set to increase over the next few months as the stage 3 income tax cuts kick in, the Board will be hoping that the increase does not flow into more overseas holidays and increased demand. The RBA would really like aggregate demand to come down much closer to aggregate supply sometime soon! However, the wealth impact of (once again) rising house prices will need to be watched.

Monthly CPI up again

The Board was also hit by another small increase in the Monthly CPI index for April (see chart below). While the April release contains the least amount of new pricing data (including for many service items), the Board must feel uneasy to see inflation failing to decrease for the fifth month in a row.

As Bullock mentioned in her media conference, the Board is eager for more detailed CPI data but will have to wait until the release of the June quarter CPI result on 31 July. This will then be fed into the RBA models in August (along with other recent data) to provide new RBA CPI estimates as an input into the Boards’ August meeting.

The labour market remains tight

Job’s growth continues to slow and vacancies are much lower than a year ago (see chart below) but the labour market remains tight with unemployment actually decreasing slightly in May (seasonally adjusted) after three months of slight increases. The post-pandemic increase in immigration has taken some steam out of the market but the market remains tight.

Bullock and the Board are keen to maintain the post-pandemic job gains but inflation must behave itself. It’s inflation first and jobs second. The longer inflation takes to get back to the RBA’s target band, the narrower the RBA’s path to a soft landing becomes.

But what about falling interest rates overseas?

Several central banks began cutting interest rates this month including in Canada, the Euro zone. and Switzerland. However, countries like Canada raised their rates earlier and higher than Australia. As a result, their inflation has fallen further and their economies have slowed much more. So unlike Australia, it makes sense for them to start cutting rates.

Impact on the Australian Private Debt Market

While the RBA waits for more data that either confirms their worst fears or lets them take a sigh of relief, private debt investors can continue to enjoy high floating rates while the economy slows but remains in reasonable shape.