There is no rest for the wicked and so after a short pause, the RBA is back at it again. Dr Lowe raised the cash rate by another 25 bps on Tuesday with the promise of more increases if needed. Inflation may be slowly falling, but not fast enough for the boffins in Martin Place.

What the RBA said

“Inflation in Australia has passed its peak, but at 7 per cent is still too high and it will be some time yet before it is back in the target range.”

“Goods price inflation is clearly slowing due to a better balance of supply and demand following the resolution of the pandemic disruptions. But services price inflation is still very high and broadly based and the experience overseas points to upside risks.”

“Wages growth has picked up in response to the tight labour market and high inflation. At the aggregate level, wages growth is still consistent with the inflation target, provided that productivity growth picks up.”

“Some further tightening of monetary policy may be required to ensure that inflation returns to target in a reasonable timeframe, but that will depend upon how the economy and inflation evolve.”

Statement by Philip Lowe, Governor: Monetary Policy Decision, 2 May 2023.

https://www.rba.gov.au/media-releases/2023/mr-23-10.html

What to expect next

Inflation has peaked but the RBA is watching services inflation

Inflation for the March quarter fell to 7 percent on an annual basis confirming the trend from the less accurate monthly inflation indicator that inflation had peaked in December. This is good news, but there is a long way to go before the RBA gets inflation back to its 2-3 percent target range.

Compared to the previous quarter, inflation rose 1.4 percent in March 2023. This was the smallest increase since December 2021, which was when first inflation started to accelerate.

However, while goods inflation looks like it is now under control after its COVID boost, services inflation is still increasing and is at its highest annual rate since June 2001 (see chart below).

The three service areas with the largest increases in inflation since December 2021 are domestic travel and accommodation (25 percent), tertiary education (17 percent), and other household services (11 percent).

The tightness in the labour market has likely contributed to the high inflation in these three areas. For example, the accommodation and food industry currently has the second-highest vacancy rate among all industries at 41.7 percent for February (see chart below).

Labour tightness and its impact on these services will likely fall as the economy slows and unemployment rises.

There was also some pent-up demand with domestic travel and accommodation which should have now returned to normal. So while services inflation is still rising, it should start to slow soon, which will take pressure off the RBA.   

The economy continues to show signs of slowing down

Despite continuing low unemployment, the squeeze on consumers is becoming more visible in their spending and shows that higher interest rates are starting to bite.

Consumer’s discretionary spending rose 5.8 percent in February on an annual basis which is the smallest increase since January 2022. Overall spending rose 11.8 percent compared to 17.8 percent in January.

New loan commitments for housing continue to fall while dwellings under construction are on its way down (see chart below). A slowdown in housing is a good leading indicator of a slowing economy.

Impact of the rate increase on the Australian Private Debt Market

With the economy remaining strong, higher interest rates represent higher returns with little increase in risk in the private debt market. Monthly business turnover in February showed increases for 9 of the 13 industries. It seems businesses are not yet feeling as much of a squeeze as the consumer.