Should Australia have raised interest-rates today?

As the UK returns after its May Day break we find the economic news being set in a land down under.

At its meeting today, the Board decided to leave the cash rate target unchanged at 4.35 per cent and the interest rate paid on Exchange Settlement balances unchanged at 4.25 per cent.

That is from the Reserve Bank of Australia and gives us our first perspective which is that the expected interest-rate cuts for 2024 have not yet materialised. Indeed there has been talk in some circles of another rise down under. Let us look deeper via the inflation numbers.

Recent information indicates that inflation continues to moderate, but is declining more slowly than expected. The CPI grew by 3.6 per cent over the year to the March quarter, down from 4.1 per cent over the year to December. Underlying inflation was higher than headline inflation and declined by less. This was due in large part to services inflation, which remains high and is moderating only gradually.

As you can see the central bankers continue their obsession with core inflation although there is perhaps a sign of how badly things have gone for it by the rebadging as underlying inflation. But there is a much bigger issue of perspective here which I shall illustrate by jumping into the TARDIS of Dt.Who and taking us back to February 2022.

Inflation has picked up more quickly than the RBA had expected, but remains lower than in many other countries. The headline CPI inflation rate is 3.5 per cent and is being affected by higher petrol prices, higher prices for newly constructed homes and the disruptions to global supply chains.

So inflation was pretty much the same as now but expected to rise. So interest-rates were what 5% or more?

At its meeting today, the Board decided to maintain the cash rate target at 10 basis points and the interest rate on Exchange Settlement balances at zero per cent. It also decided to cease further purchases under the bond purchase program, with the final purchases to take place on 10 February.

Yes they dealt with a much worse inflation situation with an interest-rate of 0.1% and now think 4.35% is appropriate. I do not think they get enough criticism for this. I added the second sentence in the quote above because they were also actively trying to feed inflation via more QE bond purchases until that day. As the nutty boys put it.

Madness, madness, they call it madness
Madness, madness, they call it madness
I’m about to explain
A-That someone is losing their brain

In fact their deep technical expert analysis based on underlying inflation was that things were going to turn out just fine.

 In underlying terms, inflation is 2.6 per cent. The central forecast is for underlying inflation to increase further in coming quarters to around 3¼ per cent, before declining to around 2¾ per cent over 2023 as the supply-side problems are resolved and consumption patterns normalise.

Yet a year later they were forced to say this.

In Australia, CPI inflation over the year to the December quarter was 7.8 per cent, the highest since 1990. In underlying terms, inflation was 6.9 per cent, which was higher than expected.

Back to today

This morning the RBA persisted with its argument that what is in fact a lagging indicator is a leading one.

The persistence of services inflation is a key uncertainty. It is expected to ease more slowly than previously forecast, reflecting stronger labour market conditions including a more gradual increase in the unemployment rate and the broader underutilisation rate. Growth in unit labour costs also remains very high.

The reality here is that the rise in goods prices made real wages fall and services buy less for the same amount so we are seeing a realigning. Also there are signs that an adjustment is taking place.

At the same time, household consumption growth has been particularly weak as high inflation and the earlier rises in interest rates have affected real disposable income.

We have discussed on other occasions what have higher interest-rates achieved? Well here we see an example of them working although as you can see things get worse before they get better. But again our central bankers just seem confused.

Growth has slowed considerably over 2023 – driven by weak growth in the household sector. This is helping to bring the level of demand back into balance with supply. However, our assessment is that demand remained above the economy’s ability to supply goods and services without putting upward pressure on inflation.

Full Employment

Australia has more than full employment according to the central bankers.

Both the unemployment rate and the broader hours-based underutilisation rate remain lower than estimates of rates that are consistent with full employment, resulting in negative ‘gaps’

The actual levels are below.

The unemployment rate was 3.8 per cent in March, slightly above its 50-year low of 3.5 per cent in late 2022, and remains below estimates of the rate consistent with full employment.

So let me explain what “full employment” means. Sadly it is not that everyone has a job. It assumes that some are always going to be changing jobs so there is a type of base level for unemployment. Back pre credit crunch it was assumed to be around 4.5%. Actually a lot of theoretical economic numbers were 4.5% but that is another story. Putting it another way real wages should be rising as we have more than full employment.

But there are all sorts of problems with this if we return to the real world. I have just hinted at one.

Real disposable incomes have declined sharply over the past 18 months (Graph 2.10). Strong growth in nominal incomes has been offset by high inflation,

Real wages have in fact fallen and at 4.2% wages growth does not seem high to me if you allow for the inflationary surge just seen.

Also there is the issue highlighted in my home country the UK by the problems with the labour force survey. Can we trust the unemployment numbers?

Next up is the weak consumption numbers we looked at earlier.

Finally there is the whole issue of using equilibrium unemployment as a measure. Again returning to the UK it was a disaster ad became a laughing stock during the tenure of the “unreliable boyfriend” Mark Carney as Bank of England Governor.

Comment

The economic situation in Australia is complex. The RBA does not mention the money supply in its release but its last chart pack showed broad money growth to be around 5%. Bringing it up to date I note that in March broad money went above US $3 trillion for the first time. But more applicable for our purposes the annual rate of growth is 4.9% having seen monthly rises of 0.7% in February and 0.3% in March. On this basis  there is little or no scope for interest-rate cuts.

There are other signs that the economy may still be running hot.

Australia’s property market is showing no signs of slowing down, with data from CoreLogic showing property prices increased by 0.6 per cent in April.

It’s the 15th month in a row that Australia’s property prices have increased, with the national median dwelling value now $779,819. ( ABC)

Plus someone seems to have lit a light under rents.

Capital city advertised rents have grown by nearly 10 per cent over the past year, with growth broadly based across cities; growth in actual rents paid by new tenants has been a little higher than this over the past year but growth has now slowed to be closer to that of advertised rents.  ( RBA)

So whilst others are contemplating interest-rate cuts Australia may yet see another rise.