The cash rate remains on uneasy pause at 4.10% is the verdict after the first monetary policy meeting presided over by new RBA Governor, Michelle Bullock. Essentially the economic backdrop to the rate decision has not changed. In the words of the new Governor and previous Governor Lowe, “Inflation in Australia has passed its peak but remains too high and will remain so for some time yet”. For as long as the RBA Governor has reason to repeat this inflation sentence at interest rate setting meetings the cash rate either stays at 4.10% or needs to be tweaked higher.

Another interest rate setting meeting has passed without a tweak higher in the cash rate but the pressure to tweak higher has if anything edged stronger. Essentially, the RBA needs evidence that higher interest rates are working towards slowing demand in the economy enough to bring down inflation to 2-3% range in a reasonable timeframe. There is evidence of some slowing demand and stress in parts of the household and business sectors but mixed with evidence of resilience in other parts.

Progress reducing inflation has been patchier over the past month or so. Goods prices have been falling for the most part, but service prices are high and are still edging up. Housing inflation remains high with house prices closing in on record highs in many areas.

The lift in petrol prices over the past two months is also adding to the stickiness of Australian annual inflation around the 5% mark. Moreover, higher petrol prices are becoming harder for the RBA to “read through” as temporary, given the reasons why giant oil producers Saudi Arabia and Russia are working to constrain global oil supply and hold up prices. The war between Israel and Hamas in the Gaza strip could lead to a further squeeze on Middle Eastern oil supply leading to even higher petrol prices in Australia over coming months.

Nothing the RBA does with interest rates will make any difference to global oil supply shortages, but it can make some difference to the trajectory of the Australian dollar exchange rate. It is the combination of the international oil price and exchange rate that is one key determinant of local petrol prices.

Also, the longer petrol prices stay high the more likely they feed supply chain price pressure. This is what is threatening to occur in Australia if high petrol prices persist and may become a reason for the RBA to try and suppress demand even more than it is aiming to do currently.

Another part of the economy that the RBA continues to monitor closely is the tight labour market. The RBA expects that one consequence of its efforts to restrain demand will be an easier labour market, evidenced by some rise in the unemployment rate above 4% for a period. Easier labour market conditions are important to help ensure that wage growth does not push up to territory that underpins inflation above its 2-3% target.

Defining what pace of wage growth will help to achieve the RBA’s 2-3% inflation target is difficult. The RBA’s latest August Monetary Policy Statement economic forecasts imply wage growth (on the wage price index) needs to peak around 4.1% y-o-y late this year and early next year to help to deliver inflation pushing below 3% y-o-y in the second half of 2025.

Since that forecast was made, however, there has been evidence in the Q2 GDP report that labour productivity remains much weaker than hoped and that demand in the economy is running firmer than expected. The labour market is running tighter than the RBA forecast back in August with stronger-than-forecast employment growth. On balance, the RBA is closer probably to considering that labour market conditions and the associated likely wage growth will delay achieving its 2-3% inflation beyond the second half of 2025.

The RBA will deliver its next set of economic forecasts in the November Monetary Policy Statement due out the Friday after the 7th November interest rate setting meeting. Some key economic statistics due for release later in October will likely determine the adjustments that the RBA needs to make to its November economic forecasts and whether those adjustments generate a need to hike interest rates further.

The first key set of statistics is the September labour force report out Thursday 20th October. Another strong lift in employment above 35,000 together with the unemployment rate holding at 3.7% or pushing down would increase the likelihood of a November rate hike. The pressure for the RBA to hike would be reinforced if the Q3 CPI report out on Wednesday 26th October shows headline and underlying inflation around 5% y-o-y or higher.

It is possible that the September labour force report and Q3 CPI come in softer than indicated above, but that is what is needed if the RBA is to maintain the interest rate pause at 4.10% next month. We are sticking with our forecast that the cash rate will stay on hold at 4.10% through to late next year, but with no great confidence. We admit that our forecast is dependent mostly upon a softer turn in the labour market and inflation data out later this month.

We are more confident forecasting that the cash rate will need to stay at least at 4.10% through to the second half of next year. Labour market conditions would need to ease substantially (the unemployment rate pushing up quickly to 4.5% or higher) with inflation pushing down below 4% y-o-y in early 2024 to provide the conditions that would allow the RBA to start cutting interest rates in the first half of 2024. Such a rapid deterioration in economic conditions is possible but very unlikely given recent developments in house prices and the labour market.