The focus this week in Australia is the RBA’s policy meeting today and tomorrow. The cash rate is expected to remain unchanged at 4.35% and the main point of interest is whether the RBA is still relatively hawkish hinting that further rate hikes cannot be ruled out, effectively code for don’t expect any rate cut until late this year or even 2025. Financial markets are banking on a softening in the RBA’s rhetoric opening the door for rate cuts starting from Q3 2024 with the odd optimist looking for a Q2 2024 start.

Our view is that the RBA will stay hawkish this week recognising that progress reducing inflation so far needs to be sustained by comparatively tight monetary conditions if inflation is to return inside 2-3% target later next year. While growth in aggregate demand, or GDP, as well as labour market conditions are softening, one key component determining the inflation outlook, wage growth, is running too high – above 4% y-o-y according to the wage price index and closer to 5% according to most other measures.

The softer labour market conditions evident over recent months – lower job vacancies; falling hours worked; slowing employment growth; and rising unemployment rate – could help to place a brake on wage growth, but there is little evidence that this has started to occur so far.

The slow feed-through from softening labour market conditions starting to cap wage growth could be partly a function of labour market conditions moving from extraordinarily tight to not so tight, but still tight by historic comparison. Job vacancies are still much higher than before the onset of the covid pandemic and the unemployment rate, while up recently is a percentage point lower than it was pre-covid.

Another reason for the slow feed-through has been the Government’s policy push to lift wage growth. The Government has pushed actively for a return to real wage growth generally and very big wage increases have been promoted for deserving and previously underpaid parts of the workforce, notably age-care and pre-school workers. The minimum wage has been lifted to reflect inflation at its highest point.

Other sectors of the workforce with bargaining power have pushed for wage increases as high as those for the special deserving groups, notably at the ports and currently in electrical trades. More generally, the benchmark for most wage claims is pushing above 4% y-o-y, not below as the RBA would like.

The higher wage growth ship is moving full-steam ahead and looks set to take some effort to brake and slow. If wage growth stays higher for longer it will also add to the sharp lift in growth in household disposable income that is likely to occur mid-2024.

The lift in household disposable income will be primed by a lesser income tax burden from July 2024, helped by a marked calming of the gale-force headwind from rising home loan interest rates through 2023, and added to by the turn to rising real wage growth that started in Q4 2023 and is gaining momentum in 2024. Any further cost-of-living relief provided in the Government’s May Budget will add more fuel to growth in household disposable income.

It is possible that households will choose to commit higher disposable income towards saving rather than spending. That would be an outcome most likely to help bring inflation down and allow the RBA to start cutting the cash rate later this year. However, the RBA will want to see much more data relating to spending and saving to be confident that households are not likely to spend too freely.

At this point, wage growth is pointing towards risk of higher household spending growth ahead and while that remains the case the RBA is likely to stay reluctant to lower the cash rate.

Apart from watching the RBA tomorrow, financial markets will also be watching the policy meetings of the US Federal Reserve, the Bank of Japan, the People’s Bank of China and the Bank of England all later this week.

The only one of this group able to cut its official interest rates is the Peoples’ Bank of China given substantial excess capacity and deflationary pressure in China’s economy. Yet it may pass and leave its loan rate unchanged at 3.95%.

The US Federal Reserve is also expected to leave its high 5.50% funds rate unchanged. Aggregate demand growth is strong in the US underpinned by income growth. Wage growth well above 4% y-o-y is too high and threatens to keep inflation tracking close to 3% and higher rather than the Federal Reserve’s 2% target. If the Federal Reserve has any leeway to cut rates it is very small and not likely before late 2024.

The Bank of England is dealing with an economy in recession but with wage growth travelling above 6% y-o-y. The Bank of England’s Base Rate is high at 5.25%, but the pressure remains to keep it high while wage growth is high enough to underpin inflation.

The Bank of Japan is also dealing with an economy close to recession, but it is also the last major central bank with super-accommodating monetary policy and an official interest rate at -0.10%. After decades of economic underperformance and periods of deflation, inflation above 2% y-o-y has been achieved and warrants less expansionary monetary policy. The Bank of Japan is likely to hike its official interest rate 10bps this week from -0.10% to zero.

Broadly speaking, financial markets at the turn of this year were too optimistic about how soon and how much most major central banks could cut interest rates. In many economies including the US, Europe and Australia wage growth is too high and threatens to slow or even halt progress getting inflation down to central bank targets. As a result, central banks need to leave official interest rates higher for longer and that is the message we expect to hear reaffirmed by the RBA tomorrow and later in the week by the US Federal Reserve and the Bank of England.