Several economic data reports and announcements over the next three weeks will determine how long it will be before the RBA can consider cutting the cash rate. The March labour force report last week showed still tight labour market conditions and points towards no rate cuts this year. That rate cut timing may come back to later this year if the Q1 CPI report out on Wednesday this week shows inflation below 0.8% q-o-q or 3.4% y-o-y for the CPI and 3.9% y-o-y for underlying inflation. Even if Q1 inflation comes in on the low-side any return to hope for a late-2024 rate will then run the gauntlet of the of the forecast changes that the RBA may need to make in its May Monetary Policy Statement (out May 7), the Federal Government’s Budget (May 12) and the Q1 wage price index (May 15).
Our view is that the CPI report out this week is likely to come in around 0.8% q-o-q and on its own will push out the timing of a rate cut to 2025. Even if we are wrong and the Q1 CPI is lower than expected, the RBA will still need to adjust higher its late 2024 and early 2025 inflation forecasts when it releases the Monetary Policy Statement. The reasons for the upward inflation forecast adjustments are that the labour market is running tighter currently than the RBA forecast previously and wage growth is higher too.
Just a brief reminder, the February Monetary Policy Statement forecast the average monthly unemployment rate at 4.2% through Q2 2024 with the Q2 wage price index at 4.1% y-o-y.
The unemployment rate was 3.8% in the March labour force report released last week and the Q1 wage price index showed annual wage growth at 4.2% y-o-y, up from 4.1% y-o-y in Q3. Heading into Q2 2024, the unemployment rate is holding down below 4% and wage growth has shown signs of acceleration consistent with still tight labour market conditions. The RBA will need to revise higher its June 2024 forecasts of employment growth (February forecast +2.0% y-o-y) and wage price index change (February forecast +4.1% y-o-y) and revise lower the unemployment rate (February forecast 4.2%).
These likely RBA forecast changes will in turn increase household disposable income growth in the second half of 2024 and probably household consumption spending growth too. These forecast changes underpin inflation at a higher level than forecast previously and hence the need for the RBA to adjust upwards the December 2024 and June 2025 CPI inflation forecasts, respectively 3.2% y-o-y and 3.1% y-o-y in the February Monetary Policy Statement.
These upward changes to inflation forecasts become necessary even if the Q1 2024 CPI report this week provides small leeway to adjust down the RBA’s Q2 2024 CPI forecast, 3.3% y-o-y in the February Monetary Policy Statement.
Continuing tight labour market conditions are one part of the story driving a longer fight to bring inflation down inside the RBA’s 2-3% target range. Another part is diminishing assistance from government budget spending helping to contain growth in aggregate demand.
Notwithstanding various cost-of-living relief assistance benefits for households provided by the Federal Government in the 2023-24 Budget, the removal of the low-and-middle-income tax rebate meant a higher tax burden for many exerting net downward pressure on growth in household disposable income through 2023-24. The Government through its Budgetary expenditure and receipts was helping to dampen household spending growth. It was working with the RBA to contain growth in household spending reducing a key part of the demand pressure promoting inflation.
In 2024-25 the Government’s spending and taxing will turn towards adding to growth in household disposable income. There are likely to be more cost-of-living relief measures announced in the Budget, albeit on lesser scale than in 2023-24, but combined with the already announced and legislated income tax cuts taking effect from July 1, 2024. Household disposable income growth at the time the time the tax cuts start to take effect will also be supported by real wage growth.
At the beginning of the 2023-24 financial year, the wage price index was up 3.7% y-o-y, but CPI inflation was 6.0% y-o-y. In short, real wage growth was -2.3% y-o-y. When the income tax cuts come into effect at the beginning of the 2024-25 financial year, the wage price index is likely to be up around 4.3% y-o-y with the CPI up around 3.4% y-o-y. Real wage growth will be around 0.9% y-o-y or 3.4 percentage points stronger than it was at the beginning of the current financial year. The Government’s budgeted income tax cuts will add strongly to the growth in household disposable income from much stronger real wage growth this July compared with last July.
The Government’s budgetary position in 2024-25 by virtue of the income tax cuts alone will be working against the RBA’s efforts to contain growth in aggregate demand and inflation. But there are also signs that the Government will announce longer term spending initiatives aimed at improving Australia’s national security – subsidising more manufacturing in Australia whether for defence, climate mitigation or to secure security of key supplies.
These types of initiative often work against promoting efficient, cost-effective Australian production. At worst they can lead to support for high-cost industries adding significantly to the price of goods and services over time. National security initiatives that limit access to low-cost imports may support local businesses, but they also deny the benefits of lower internationally traded goods prices to Australian businesses and consumers.
The 2024-25 Budget could become the factor that not only adds to pressure pushing the first rate cut into 2025 but makes it late 2025 or even 2026 before a rate cut can occur.