Writing about the outlook beyond the RBA’s rate pause last week we considered that the various opposing factors influencing the cash rate outlook favoured a lengthy pause at 3.60%. Our view required continuing evidence of soft growth in household spending and employment. On balance, the relatively strong data and survey releases over the past week have pushed the RBA cash rate dial off continuing pause and back in favour one more rate hike at least.
The March NAB business survey showed the response to the current business conditions at a strong +16 only off one notch from +17 in February. The reading is strong enough that businesses are on balance still likely to be trying to employ more people and are probably comfortable about expanding their margins by lifting prices if they need to. The current business conditions part of the survey is consistent with a still difficult task ahead for the RBA to bring inflation down to 2-3% target.
The forward-looking business confidence response to the NAB survey improved to -1 in March from -4 in February. That reading implies some concern about future business conditions, but it is not especially weak. Moreover, when the rate pause in April is factored in to the survey the likelihood is that business confidence will move in to positive territory.
Consumer sentiment has also improved according to the Westpac April consumer sentiment survey. The survey was taken in the wake of the RBA’s decision to pause at its early-April policy meeting and showed a lift of 9.4% m-o-m. The bounce came off a low index base, well below the long-term average for the survey, but it still points to the potential for sentiment to lift on any good news and places in doubt the RBA’s forecast that household consumption spending growth will continue to slow this year, almost a pre-condition to ensure sufficient reduction in inflation over the next two years.
The March labour force report released last week was a clincher shifting the dial towards another rate hike. The survey needed to show a modest lift in employment, around +20,000 or less, coming after the out-sized February 64,000 lift that took the unemployment rate down to a near 50-year low of 3.5%. The lift in employment in March was out-sized again, up 53,000 (including a 72,200 rise in full-time employment) and kept the unemployment rate down at 3.5%, a rate that if maintained for much longer is low enough to ensure accelerating increases in wages.
Ahead of the next RBA policy meeting on the 2nd May, the RBA will see the Q1 CPI report (due 26th April). Annual CPI inflation in that report should decelerate to around 7.0% (our forecast is 6.9%) from 7.8% in Q4 2022. However, underlying annual inflation as measured by the trimmed mean is likely to fall by much less than the headline CPI, to around 6.7% in Q1 2023 from 6.9% in Q4 2022. The stickiness of high inflation is highlighted by slow progress getting underlying inflation down.
The Q1 CPI report is likely to reinforce the need for the RBA to hike rates again. The annual inflation reading around 7.0% is likely to the figure proposed for lifting the minimum wage in the approaching Minimum Wage Case. In the still very tight labour market, others not on the minimum wage will also be looking for “cost of living” compensation approaching 7.0% in their claims.
If wage claims migrate only partly towards 7.0%, that is inconsistent with the RBA’s hope that wage claims reflect where inflation is going – eventually down to 3% - not where it has been.
The wage price index will pick up higher wage claims with a lag. The next Q1 2023 wage price index reading out in mid-May will probably see an increase from 3.0% y-o-y registered in Q4 2022 to nearer 3.5% in Q1. That will still be a tolerably low reading from the RBA’s point of view but there is a building risk that it accelerates quickly above 4.0% y-o-y this year, wage growth inconsistent with the RBA achieving a return to 2-3% inflation over the next two years.
Another factor to add to the RBA cash rate outlook is the admission last week by some RBA board members that they had done a terrible job containing inflation and had lifted interest rates belatedly and too slowly in the face of the inflation threat in 2022 evident as demand soared from too much government spending in the pandemic allied with too loose monetary conditions. After making that admission, the RBA board will want to prove that it is containing inflation now.
Our view about the RBA rate outlook has changed in the wake of the strong economic readings over the past week and we now expect the RBA to hike the cash rate another 25bps to 3.85% at its May policy meeting. Beyond the May meeting we will be looking to the balance of strength in the readings of retail sales, business and consumer sentiment, labour market, wage growth and inflation. If, on balance, these indicators take a softer turn, the RBA will have the opportunity to pause again, but if they stay strong another rate hike, beyond the expected May rate hike, may be needed.