The June monthly CPI and the Q2 CPI out this week will influence whether the RBA pauses again or hikes at the next policy meeting on 1st August. Outcomes around the consensus forecasts of 5.5% y-o-y for the June CPI and 6.2% y-o-y for the Q2 CPI while showing that annual inflation continues to cool are unlikely to be low enough to allow the RBA to counter evidence that the labour continues to run hot and will generate wage growth that will prevent inflation returning consistently to 2-3% target and within a reasonable timeframe. If the two CPI reports show materially lower-than-expected annual inflation this week the RBA could pause in August, but the odds favour a 25bps hike simply because the strength of the labour market trumps the moderation in annual inflation for the time being.
The June labour force report released last week showed total employment rising more than double expectations, up 32,600 with full-time positions up 39,300. The big employment rise follows the outsized 76,600 May employment lift. The May and June employment readings cap a stellar year of employment growth, up 409,900, or 3.0% in the financial year ending June 2023.
Strong employment growth even when matched with a high participation rate at a near record 66.8% in June 2023 has kept the unemployment rate hovering around its lowest level since 1974 throughout 2022-23. In June, the unemployment rate stayed near its cycle low point of 3.5%. May initially reported at 3.6% was revised down 3.5%.
The low national unemployment rate is also becoming consistently low in the states and territories with unemployment rates mostly in a narrow range of 3.3% (Northern Territory) to 3.9% (ACT) and only two outliers South Australia, 4.2%, and New South Wales, 2.9%, the first time below 3% in more than half a century.
Relative to the RBA’s most recent economic forecasts produced in the early-May Monetary Policy Statement, June 2023 total employment is higher, and the unemployment rate is lower than forecast. The RBA cannot avoid needing to revise stronger its December 2023 forecasts of employment growth, the unemployment rate and wage growth in the early-August Monetary Policy Statement. These forecast revisions will be part of the discussion about the cash rate at the August policy meeting. The revisions to forecast labour market conditions imply at the very least a more protracted battle getting inflation down to target.
If it were down to just the latest labour force report and its likely impact forcing revisions to the RBA’s forecasts of labour market conditions in December 2023, the RBA would have little choice but to hike the cash rate in August and probably 25bps to 4.35%. Muddying the waters, however, is the greater-than-expected slide in annual inflation over the last month or two not just here in Australia, but also in the world’s major economic regions including the US and Europe.
The deceleration in annual inflation is in large part down to lower energy prices and stabilising or lower goods prices assisted by the continuing easing of supply-chain pressure. This downward pressure on CPI inflation from energy and goods prices is tempering the impact of higher housing and services prices.
In Australia, it is possible that more modest change in petrol prices and goods prices as well as fresh food prices have provided greater offset to services and housing inflation than analysts have forecast for the approaching June and Q2 CPI releases. It is possible that the June month CPI could show annual inflation below 5.5% y-o-y and that the Q2 CPI report could show annual inflation below 6.2% y-o-y, conceivably below 6.0%. If these lower-than-expected outcomes eventuate, financial markets would jump on the “low” inflation news increasing the probability of an August rate pause.
The excitement could prove to be premature. The problem is that some of the drivers producing lower inflation look temporary, especially here in Australia where gas and electricity prices will reset much higher in July and August. Most likely, the recent downward pressure on annual inflation will stall and possibly even reverse higher temporarily in the July and August monthly CPI readings and the Q3 CPI report.
In any case even if the June and Q2 CPI reports are lower than expected annual inflation will still be above 5% on the monthly report and nearer to 6% on the quarterly report, not exactly low relative to the RBA’s still well out of reach 2-3% target band or the current 4.10% cash rate.
While there is some excitement this week that the CPI reports out on Wednesday may prompt the RBA to remain on hold in August, we still see the cards stacked in favour of a 25bps rate. Moreover, if the July labour force report out in mid-August is strong again and the Q2 wage price index shows annual wage growth accelerating towards 4% y-o-y or higher we see the RBA needing to hike another 25bps to 4.60% at the early-September policy meeting.