The Reserve Bank of Australia gets another inflation headache

This morning the economic news agenda is being set by a place down under and in particular by this.

The monthly Consumer Price Index (CPI) indicator rose 4.0 per cent in the 12 months to May 2024, up from 3.6 per cent in April, according to the latest data from the Australian Bureau of Statistics (ABS).

The most significant contributors to the annual rise to May were Housing (+5.2 per cent), Food and non-alcoholic beverages (+3.3 per cent), Transport (+4.9 per cent), and Alcohol and tobacco (+6.7 per cent).

So we have a rise in the annual figure which means that the pressure on the Reserve Bank of Australia is building. Back on the 7th of May it told us this.

Recent information indicates that inflation continues to moderate, but is declining more slowly than expected.

That has not had a good morning and whilst this is a monthly rather than a quarterly number it is not following what we were told. Back on the 7th of May I pointed out this.

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

The Reserve Bank of Australia

We can review this in the light of the words of Deputy Governor Kent who spoke in Melbourne earlier.

The tightening in monetary policy over the past two years is underpinning restrictive financial conditions in Australia. This is contributing to slower growth of aggregate demand, thereby helping to bring the level of demand into better balance with supply and lower inflation.

It was not the best of days to be claiming that! But there is more and let me remind you of this from my article on May 7th.

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.

The money supply is not showing that things are restrictive and seemed to be suggesting another push. I can update that now with the April figures which were 0.4% on the month raising the annual rate to 5.1%. So if we look ahead 18/24 months for inflation to be running at 2% we would need growth of 3% and the latter does not look likely as we recall Australia is in a GDP per capita recession and depression. So there is a clear risk for inflation two years ahead.

So things are not going very well for the claim that policy is restrictive and presumably inadvertently he confirms this.

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

Central bankers use the word “vigilant” when they fear things are going wrong due to their actions but want to make it look like they have been on the case. We get a confirmation of the public relations effort here.

Monetary policy is the key determinant of financial conditions for households and businesses. Since May 2022, the RBA has raised the cash rate target by 425 basis points.

As you can see he is presenting himself as a doughty inflation warrior. His problem is that it is starting to look like it is not enough. As an aside central bankers seem to have made a pack decision that basis points sounds so much more macho than percentage points as 425 basis points is the new 4.25%.

Theory beats Reality Again

You might think that after the disaster where theories about Transitory inflation went so wrong, you would throw away the failures. But no we have an effort to measure things via something we er can’t measure!

One way to gauge the stance of monetary policy is to compare the cash rate with estimates of the nominal neutral interest rate.

We do get a confession of this if you follow closely.

Definitions of the neutral rate vary,

It is one of those concepts like marking your own homework as the neutral rate as measured by Deputy Governor Kent is below the actual one and policy is restrictive.

but in essence it is the level of the cash rate that would neither stimulate nor restrain demand; in other words, it would underpin a balance between demand and supply of goods and services and in the labour market, with inflation consistent with the inflation target.

That is the numerical equivalent of a word salad. Let me pick out one area which I highlighted on May 7th.

Putting it another way real wages should be rising as we have more than full employment.

Except they have fallen and are not catching up much (made worse by the inflation rise). I pointed out back then the UK had problems with its labour market figures and since then the US has produced a non-farm payroll release where employment was strong ( Establishment Survey) and falling ( Household Survey) at the same time. So all the available evidence suggests that our knowledge of the labour market us struggling. But that is ignored and we get this.

In May, the median estimate among market economists implied that the cash rate was around 1 percentage point above the nominal neutral rate.

Note how is using others as a backing for his fantasy. Although I note that he then feels the need to cover his tracks.

That said, estimates of the neutral rate are subject to considerable uncertainty, so the extent to which monetary policy is restrictive is unclear. Also, the neutral rate can change over time.

Should things go wrong then this is the bit that future speeches will refer to. After a suitable delay the neutral rate will be back as it is o easy to manipulate.

Last thing I remember, I was running for the door
I had to find the passage back to the place I was before
“Relax, ” said the night man, “We are programmed to receive
You can check out any time you like, but you can never leave” ( The Eagles )

We can return to the money supply issue because we are presented with a “dashboard of indicators” with eleven different measures and not one of them is the money supply. Can anybody think why?

Comment

One definition of intelligence is that you learn from your mistakes. Yet we see that central bankers keep making the same ones and in particular they keep preferring theory to reality. That is added to by speeches like this which are presented as research into the facts but only cover the facts which suit the narrative. Indeed they also at times look to change the narrative as I note this from Mohammed El-Erian.

The inflation dynamics are more complicated than most realize; and We should be more open-minded about the inflation targets given secular realities.

Can anybody guess which way we will have to be more “open-minded”?!

The real issue for me is less the inflation rise today as the situation with the money supply. That does not show that policy is restrictive. Another measure used to be that you needed to get interest-rates above inflation for a sustained period with some arguing it needed to be 2% above. Then we have the issue that I looked at on the 5th of this month which is the way the Aussie economy is struggling. Things look really rather stagflationary at the moment. Whilst we are looking at headaches for the RBA then the rise in the 3 year yield by 0.2% to 4.15% makes its QE portfolio look even worse.

Let me finish with some hope as many Aussies were wise enough to ignore the lower for longer Forward Guidance from their central bankers.

Pass-through has been a bit less than in the past because of the high share of mortgages fixed at low rates during the pandemic.

 

 

 

 

Is it to be higher for longer for interest-rates?

This week is one where the main event is likely to be on Friday.That is because we will then hear from US Federal Reserve Chair Jerome Powell and he and his colleagues are responsible for monetary policy and interest-rates in the world’s largest economy. Via the US Dollar they have been effectively setting interest-rates indirectly for others too probably most explicitly for the Bank of Canada but the Bank of England hit choppy water for a while too after forgetting this.

There have been essentially two ways the Jackson Hole event has played out. The first is where a new policy is announced as for example Forward Guidance was given a public airing here. Of course it turned into quite a disaster especially for the Reserve Bank of Australia which most explicitly promised low interest-rates and then raised them sharply leading to a public apology. But at the time central bankers thought they has pulled a masterstroke. Also these policies tend to never completely disappear as only a few short months after abandoning Forward Guidance Christine Lagarde of the ECB was offering pretty explicit interest-rate promises.

Next is a simply statement of expected policy which can also have quite an impact.

A year ago, Powell chose the first strategy, delivering a shockingly short (under nine-minute) speech centred(opens a new window) on the notion that “While higher interest rates, slower growth and softer labour market conditions will bring down inflation, they will also bring some pain to households and businesses.”………This framing did more than jolt markets and trigger a large sell-off in stocks and bonds. It propagated a “pain narrative” that many media outlets employed as a benchmark

That is from an opinion piece by Mohammed El-Erian in the Financial Times. He is one of those who gets appointed to all sorts of important roles and it seems he is keen on another one!

Last, there is a case for the Fed to follow the welcomed decision by the Bank of England to institute an external evaluation of its forecasting errors — an important step to counteract the erosion of both central bank credibility and the efficacy of its forward policy guidance, as well as mitigate the potential harm to political independence.

Welcomed by those who see a potential gravy chain anyway. I am sure that in spite of his many existing roles he could find the time. After all the report will be written for him anyway.

Higher for Longer

It was interesting timing to say the least for journalist known as the “mouth” for the US Federal Reserve to publish this yesterday.

Despite the Federal Reserve’s raising interest rates to a 22-year high, the economy remains surprisingly resilient< with estimates putting third-quarter growth on pace to easily exceed its 2% trend. It is one of the factors leading some economists to question whether rates will ever return to the lower levels that prevailed before 2020 even if inflation returns to the Fed’s 2% target over the next few years. ( Wall Street Journal)

Actually there is more than a little doubt about the US economy with the Atlanta Fed GDP now cast suggesting GDP growth towards 1,5% as we would put it for the third quarter, whilst the Conference Board is expecting as recession as 2023 moves into 2024. Of course they could both be true showing an example of my brick on a piece of elastic explanation for monetary policy. But Nick Timiraos is ignoring the slow down fears. The consequence is that the idea of “higher for longer” for interest-rates is being put in the public arena.

Neutral Interest Rates

We are guided towards this concept by Nick Timiraos.

At issue is what is known as the neutral rate of interest. It is the rate at which the demand and supply of savings is in equilibrium, leading to stable economic growth and inflation.

Then we get what a version of what Americans would call the money shot, and the emphasis is mine.

With inflation now falling but activity still firm, estimates of the neutral rate could take on greater importance in coming months. If neutral has gone up, that could call for higher short-term interest rates, or delay interest-rate cuts as inflation falls.

Just in case we were going to miss the point ( very unlikely) it is then rubbed in.

 It could also keep long-term bond yields, which determine rates on mortgages and corporate debt, higher for longer.

So there is the message which has got a further reinforcement from his Twitter or X feed.

Another way to think about this: look where officials see rates settling after a few years (a point made recently by Matt Luzzetti at Deutsche Bank) Three years ago, officials projected an economy in 2024 with inflation at target and unemployment at 3.5% And a 1.8% funds rate

And now.

This past June, officials thought a funds rate around 3.4% would be warranted with inflation a little higher (2.2%) and unemployment at 4.5%.

Of course if they had any real skill at forecasting the future we would not be where we are. But this is an attempt to put the idea of interest-rates remaining at higher levels, in the quotes above an explicit number of 1.6% higher is used, in our minds.

Comment

This is clearly Jerome Powell floating a kite to see the response to it. If he was hoping that bond markets would respond then overnight and this morning he would have been disappointed. Bond yields have gone higher but by very little. There is however a more subtle point, because those who have followed the discussions on here will know that US bond yields have been rising. Over the past month the US ten-year yield has risen by more than three-quarters of a point to 4.28%. So is Chair Powell now pushing markets or did they push him? Or as Aretha Franklin put it.

Take another look and tell me, baby
Who’s zooming who?)
Who’s zooming who?
(Who’s zooming who?)
The fish jumped off the hook, didn’t I, baby?
Who’s zooming who?)
Yeah

If we look into the theoretical backing for this there are issues for example we are told this by Nick Timiraos.

The debate over where neutral sits hasn’t been important until now.

Did he take a long holiday in 2017-18? Also it is hard not to have a wry smile at this.

First described by Swedish economist Knut Wicksell a century ago, neutral can’t be directly observed.

You might think that such a concept would be perfect for a central banker. But the story of the pandemic response and subsequent inflation is that as well as getting reality wrong they even got a made up number wrong. Indeed this is an establishment issue highlighted by the prominence given to Larry Summers.

Former Treasury Secretary Lawrence Summers argued 10 years ago that slow population growth, inequality and a shortage of investment opportunities would create a glut of savings that depressed neutral. But he has recently suggested neutral has gone up because of higher deficits and the investment to transition to a lower-carbon economy. ( WSJ)

I would say that is the same as what he did to the Harvard University Endowment but there was only the down bit in that instance.

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Where next for interest-rates in the US?

It was only on Friday that we looked at the recession risks for the world economy and now as we start the business week in UK terms anyway after Her Majesty’s funeral we find that the game of chess has seen more pieces moved. Let me bring you right up to date with the Swedish move in the international game.

The Executive Board assesses that monetary policy now needs to act more than was anticipated in June to bring inflation back to the target.

We could take that wider as central banks have been behind the curve on inflation as they chanted “transitory” rather than acting as the fires were lit. Now they are rushing to catch up.

The Executive Board has therefore decided to raise the Riksbank’s policy rate by 1 percentage point to 1.75 per cent. The forecast indicates that the policy rate will be raised further over the coming six months.

This begs a few questions as logically you start with the largest increase to begin your reset then do the fine-tuning. But central banks have got this so wrong they are doing things in reverse. From our point of view we have our first stand-alone 1% increase ( the Bank of Canada move also involved some catch-up with the US) if I may put it like that and it raises expectations ahead of tomorrow.

The Federal Reserve

We looked last week at the post CPI number move to wondering about a 1% move in interest-rates and below is the Financial Times which has chosen this morning to hedge its bets.

Federal Reserve officials are under pressure to prove they are serious about stamping out elevated inflation by backing up their hawkish rhetoric with a new set of interest rate projections set to be published this week.
Following its two-day policy meeting, the Federal Open Market Committee is on Wednesday expected to raise interest rates by at least 0.75 percentage points for the third time in a row as it tries to hit the brakes on the overheating US economy.

Maybe the Federal Reserve are hoping that De La Soul were right about 3 being the magic number.

Three times one?
(What is it?)
(One, two, three!)
And that’s a Magic Number

Oh and it is hard not to have a wry smile at this. After all it getting inflation below 4% is so easy it makes you wonder why they have not done it?

Betsy Duke, a former governor at the central bank. Bringing inflation back down to 4 per cent could occur “fairly easily”, she added, but it could be “much more difficult” to get it below 3 per cent.

Remember it was these people who used to assure us that they could deal with any inflationary episode with no trouble at all.

The Neutral Rate

This is a concept that has entered the economic arena. It has pretty much replaced this one.

A key concept that guides the Federal Reserve’s monetary policy is the natural rate of interest, also known as r-star. This refers to the real, or inflation-adjusted, interest rate that is consistent with an economy at full employment with inflation stabilized at a desired target.  ( San Francisco Fed)

You can see why from this bit.

Conversely, if the real interest rate is below r-star, then monetary conditions are loose and likely to lead to lower unemployment and higher inflation.

That is what happened and in many ways the whole r* concept was designed to achieve that. But now with inflation ( CPI) over 8% and interest-rates even allowing for tomorrow’s rise more like 3% they are not very keen on pointing out policy looks incredibly loose with a real interest-rate of -5%! That is made even worse by an unemployment rate of 3.7% as they start to look incompetent.

The theoretical concept that they prefer to focus on now is this one as explained back in 2018.

The neutral rate is the theoretical federal funds rate at which the stance of Federal Reserve monetary policy is neither accommodative nor restrictive. It is the short-term real interest rate consistent with the economy maintaining full employment with associated price stability. ( Dallas Fed)

Actually the President of the Dallas Fed was aware of some of the problems here.

This rate is not static. It is a dynamic rate that varies based on a range of economic and financial market factors.

Also he did warn us that he would get the phase we have just been through wrong. The emphasis is mine.

In assessing the stance of monetary policy and making judgments about the future path of the federal funds rate, I prefer to focus on measures of the neutral rate that de-emphasize the impact of more volatile, shorter-run transitory factors. 

How did that work out?

Anyway he did get onto where he thought the neutral rate was.

 In the September SEP, the range of submissions by FOMC participants for the longer-run rate was 2.5 to 3.5 percent, and the median estimate was 3.0 percent.

So we are presently nudging into the bottom end of the range and tomorrow will be in the mid-upper part.

Bond Yields

The US ten-year yield marked a new threshold of sorts for this phase as it reached 3.5% yesterday and has moved higher today to 3.54% The two-year is edging closer to 4% and has nearly touched it. They give us our boundaries I think for where people are presently expecting the Federal Reserve to end up.

Germany

Traditionally the Federal Reserve is not much bothered by overseas events but I think the scale of the news from Germany earlier will have merited a look.

WIESBADEN – In August 2022, producer prices for industrial products were 45.8% higher than in August 2021. As reported by the Federal Statistical Office (Destatis), this was the highest year-on-year increase since the survey began in 1949. In July 2022, the rate of change was +37.2% and +32.7% in June. In a month-on-month comparison, producer prices rose by 7.9% in August 2022. This is also the highest month-on-month increase since the survey began. ( Destatis)

Even a central banker will know about soaring energy prices but the moves below for food are eye-watering as well. After all you cannot eat an I-pad.

Consumer goods prices in August 2022 were 16.9% higher than in August 2021 and increased by 0.8% compared to July 2022. Food was 22.3% more expensive than last year. The prices for butter (+74.6% compared to August 2021) and untreated vegetable oils (+51.4%) rose particularly sharply. Liquid milk cost 35.3% more than in August 2021, coffee was 32.5% more expensive than a year ago. Meat excluding poultry cost 27.5% more than a year earlier.

Comment

The economic waters have been muddied by the failure of the central banks to address the rise in inflation in 2021. Now they find themselves like a dog chasing its tail just as the future risk is economic weakness as I pointed out on Friday. You may note that the theories I have looked at above discuss what you do but crucially ignore when you do it. This matters because it is why central bankers got the interest-rate job. Essentially politicians chose to look the other way when elections were in the offing which meant that larger moves were needed later. Our modern central bankers have made the same mistake although for a different reason.

The new enthusiasm of the Federal Reserve has given everyone else a problem as the prospect of an actual interest-rate on US Dollars has driven it higher meaning that everyone else’s import costs have done so too. That explains the Riksbank move earlier as it tries to respond. The problem is that it is a case of to little too late as 1% might seem grand in a central banking meeting-room but over a year is it that big a deal?

Either way tomorrow evening I expect them to gain only 0.25% relatively as 0.75% from the US seems most likely to me.

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The ECB has shown us how lost central banks have become

Yesterday was packed with news including some especially sad news from the UK, but I want to focus on what turned out to be a fascinating policy meeting at the European Central Bank or ECB. The news from there was significant well beyond the boundaries of both the Euro area and Europe as it signaled issues that are common to so many. Let us start with the basics.

The Governing Council decided to raise the three key ECB interest rates by 75 basis points. Accordingly, the interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will be increased to 1.25%, 1.50% and 0.75% respectively, with effect from 14 September 2022.

Even such a simple statement covers a lot of ground. For example I have questioned in the past if the ECB can escape negative interest-rates? Well we have found a way it has been forced to with inflation at 9.1% although care is needed as supermassive black holes have a way of sucking you back in ( the event horizon). Also it has just equaled its largest ever rise with a 0.75% move ( there was a technical move as the Euro began).

The rationale for this comes with a really odd kicker if you include the sentence before.

As the current drivers of inflation fade over time and the normalisation of monetary policy works its way through to the economy and price-setting, inflation will come down. Looking ahead, ECB staff have significantly revised up their inflation projections and inflation is now expected to average 8.1% in 2022, 5.5% in 2023 and 2.3% in 2024.

So the interest-rate rise is in their terms in response to higher inflation expectations, Just after telling us inflation will come down! Actually they have spent the last year raising their inflation expectations after telling us it was transitory or as President Lagarde put it a “hump”. If we switch to some other news this week that sort of performance at Chelsea football club would have seen them sacked on several occasions.

The Precious! The Precious!

There was more because in spite of the fact that higher interest-rates are good for banks a central banker apparently cannot resist giving them some more sweeties.

Following the raising of the deposit facility rate to above zero, the two-tier system for the remuneration of excess reserves is no longer necessary.

So they get the Deposit Rate of 0.75% on their deposits but pay less than that on their TLTRO borrowing. In fact they were paid to borrow for a while.

In 2020-2021, European banks borrowed more than EUR 2 trillion (!) from the ECB via the so-called TLTRO operations. The borrowing conditions were extremely advantageous with interest rates as low as -1% for the Jun20-Jun22 period. ( @MacroAlf)

On average it looks as though they will make about 1.25%. Nice work if you can get it.

What can we expect next?

The international theme came firstly with the establishment of 0.75% being the standard for this series of moves ( are you listening Bank of England?). But there was more as we were guided to the future.

 Based on our current assessment, over the next several meetings we expect to raise interest rates further to dampen demand and guard against the risk of a persistent upward shift in inflation expectations.

Perhaps someone should invent a phrase for that like “Forward Guidance”. Except of course they have only just abandoned it before reincarnating it.

Plus we got some classics from President Lagarde.

Do I know exactly what is the terminal rate? No.

If it means that we have to go further than whatever rate you refer to, we will do so.

So she will go further than the interest-rate she does not know?

It gets better as we were told this.

because we will proceed meeting by meeting and on the basis of data……..and on the basis of the data that we receive.Our future policy rate decisions will continue to be data-dependent and follow a meeting-by-meeting approach……but if the data on our meeting-by-meeting review suggests that we should take a high hike of our interest rates, we will do so.

So it is the data until well see for yourselves.

 I think what I understand that to be is that we cannot be purely mathematical.

So it now isn’t the data?

Then as we recall that Forward Guidance was abandoned only one meeting ago.

What we know is that we want to get to that 2% medium-term target, and we will take the necessary steps along the way in order to get there. We think that it will take several meetings. Some people will say, “How many is several?” Well, it’s probably more than two, including this one, but it’s probably also going to be less than five. Now, I leave it to you to decide whether it’s going to be two, three or four.

So between 2 and 5 is in fact actually between 1 and 4. Which is pretty wide and probably not the best to reveal. But having put it like that you then have really rather fenced yourself in for the October decision.

This morning the attempted clarifications ( a familiar feature of the Lagarde Presidency) are not really helping. Here is the head of the French central bank.

Villeroy has been among ECB officials providing estimates of the neutral rate. He doesn’t sound quite sure about it still. *VILLEROY: ECB DOESN’T YET KNOW TERMINAL RATE *VILLEROY: EURO AREA NEUTRAL RATE BELOW OR CLOSE TO 2% ( @fwred)

It does not help to throw in another theoretical construct especially if you are not sure what it is! Even worse it is unclear which interest-rate he is referring to which matters as the ECB ones differ by 0.5%. So the clarification muddies the water further.

My opinion is that he means the deposit rate which means he is suggesting at least 1% of further interest-rate hikes this year.

Villeroy says ECB should be at ‘neutral’ by year end ( @TradingFloorAudio)

This means at least two 0.5% interest-rate increases. But apparently.

ECB’S VILLEROY: NOBODY SHOULD SPECULATE ABOUT THE MAGNITUDE OF THE NEXT STEP, WE DID NOT CREATE A NEW JUMBO HABIT. ( @financialjuice )

He has just lit the blue touch paper on such speculation.

The Euro

Next up was this. We don’t

It will not surprise you if I say that of course we do not target any kind of exchange rate for the euro.

But we sort of do.

 But of course we monitor very carefully and just like all of you, we have noted the depreciation of the euro relative to a basket of currencies but more importantly, relative to the dollar

Regular readers may recall that last time around President Lagarde hinted at an exchange-rate target.

Comment

I said at the beginning that there were shifts here way beyond the Euro area and there are two major ones. The first is that it has just set a benchmark for other central banks for the rest of 2022 and into 2023 ( technically February if you count the meetings). Interest-rates will be substantially higher ( over 2%).

Next up is that they have inadvertently revealed how confused and lost they are or as Genesis put it.

Oh, Superman, where are you now
When everything’s gone wrong somehow?
The men of steel, the men of power
Are losing control by the hour

Of course in this instance we might say Supergirl. I recall when we were assured that they would have no trouble at all in controlling inflation whereas now they admit they do not know what will be required. On its own some humility with the implication of honesty is welcome. But this is not how it has played out as they have been forced out of their previous arrogance by events. That is very different.

Lastly we were assured that there would be no recession whereas now we are told.

ECB’S VILLEROY: WE CANNOT EXCLUDE A LIMITED RECESSION. ( @financialjuice)

We return to the point I frequently make about timing. Because they have got it wrong they are acting procyclically or tightening into a slowdown. We may yet see panic cuts in 2023 to complete the shambles.

The Queen

It is an extraordinary time in another way. All my like the UK and others have only had one monarch. Rest in Peace to her and thank you for a quite extraordinary reign.