On 6 December, the RBA Board increased the official interest rates by 25 bps to 3.10 percent.

The RBA remains committed to increasing interest rates as high as needed to bring down domestic demand to a more “sustainable balance”. While the RBA notes external factors, it remains wary of domestic demand and a “very tight labour market”.

What the RBA said

“Inflation in Australia is too high, at 6.9 per cent over the year to October. Global factors explain much of this high inflation, but strong domestic demand relative to the ability of the economy to meet that demand is also playing a role.”

“A further increase in inflation is expected over the months ahead, with inflation forecast to peak at around 8 per cent over the year to the December quarter.”

“Wages growth is continuing to pick up from the low rates of recent years and a further pick-up is expected due to the tight labour market and higher inflation. Given the importance of avoiding a prices-wages spiral, the Board will continue to pay close attention to both the evolution of labour costs and the price-setting behaviour of firms in the period ahead.”

“The Board remains resolute in its determination to return inflation to target and will do what is necessary to achieve that.”

Statement by Philip Lowe, Governor: Monetary Policy Decision, 6 December 2022.

https://www.rba.gov.au/media-releases/2022/mr-22-41.html

What to expect next

The news is not all bad in the latest data releases for the Australian economy. While we may not have seen the end of the RBA’s interest rate increases, we may start the new year with some pauses.

Inflation may have turned the corner

The ABS released its new monthly CPI data series for the first time in November and it showed that while inflation remains high, it did decrease slightly in October to an annual rate of 6.9 percent (see chart below). The RBA believes that quarterly inflation will peak at 8 percent in the December quarter.

The main contributors were housing (10.5 percent), food and non-alcoholic beverages (8.9 percent), and transport (7.4 percent).

All three of these categories are largely a supply-side story, which the RBA will hope will settle down sooner rather than later. New dwellings by owner occupiers and the continued supply issues there drove the housing price increase (20.4 percent), with rents only increasing 3.5 percent. Fruit and vegetables increased by 9.4 percent, but this is a vast improvement on the 19 and 17.4 percent from August and September. The reintroduction of the fuel excise drove the increase in transport prices.

The labour market remains tight

Despite the decrease in monthly inflation, the labour market tightened even further with unemployment falling to 3.4 percent in October, which is a return to a 50-year low reached back in July. On top of this, the Wage Price Index increased by a whole one percent in the September quarter for an annual increase of 3.1 percent, which is the highest level since March 2013 (see chart below).

However inflation expectations are starting to trend down

There is good news on the inflation expectations front, with the 1-year and 2-year inflation expectations of union officials and the 1-year expectations of market economists all falling for the December quarter. If this trend continues into the next quarter, this will start to moderate any RBA fears of a wage-price spiral.

Table 1: Changing inflation expectations

Source: RBA Statistical Tables,  G3 Inflation Expectations

Retail turnover is down and so are company profits but what about household spending?

Monthly retail turnover fell -0.2 percent for October (MoM), the first decrease in 2022.  This suggests that consumer spending is starting to feel the impact of higher prices and the RBA’s interest rate increases. As we suggested last month, this is something the RBA is watching very closely.

We will get a better gauge on consumer spending when the Q3 GDP figures are released later in the week. If this shows a decrease or a small increase in household expenditure for the September quarter then this will mean that demand-side pressure on inflation is falling, which will take some pressure off the RBA to raise rates higher. It is not looking good however, as the monthly household spending indicator increased each month during the September quarter.   

On the company side, gross operating profits fell 12.4 percent for the September quarter compared to the June quarter. This suggests that businesses are not passing on some of the price increases they are facing to consumers, which will help keep CPI down going forward. Companies will also likely start to look at their number of workers going forward, which would provide some much needed slack for the labour market.

The international front

The US labour market remains strong despite the Federal Reserve’s interest rate increases so there appears to be scope for further increases in the short term.

An increase in COVID-19 cases and lockdowns in China will impact China’s  GDP for the year and should also decrease resource prices, which will have an impact on the Australian economy.

The European winter remains mild, which has kept gas prices down. The new $60 price cap on Russian oil by the EU, G7, and Australia, and the surprise decision by OPEC to not cut production further has already provided some relief to the oil price.

Impact of the rate increase on the Australian Private Debt Market

With the economy remaining strong but with the RBA likely to increase interest rates further in the new year, private debt remains an attractive proposition at this time.

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