The RBA’s first interest rate decision of 2024 on 6th February could go either way, a pause at 4.35% for the cash rate, or a 25bps rate hike to 4.60%. Economic data released since the last RBA meeting in early December show spending on housing and consumption goods and services still running at a pace that questions whether inflation is on a trajectory to glide down within the RBA’s 2-3% target range by the end of next year. Labour market conditions while starting to ease, are still tight enough to present a headwind to easing inflation and what evidence there is of easing inflation shows that progress is down to easing in goods and petrol prices with service prices still holding high.

The February rate decision is a coin toss at this stage, although the key Q4 2023 and December month CPI reports out next week may push the decision one way or the other.

For the RBA to stay on pause at 4.35%, those inflation reports will need to show annual CPI inflation below 4.5% y-o-y (Q3 was 5.4% y-o-y and November was 4.3% y-o-y). Also, the contributions to inflation need to show that service price inflation is not running any higher than around 6% y-o-y. A lower than 4.5% y-o-y overall inflation reading will not be sufficient reason to pause if it is generated only by weaker goods and petrol prices.

Post covid-lockdown improvement in goods supply chains have pulled down the prices of many goods but it is questionable whether the improvement will continue as global trade and supply chains come under renewed threat from tensions in the Middle East. To be more comfortable that inflation is on a path down to 3% the RBA will need to see some signs that high service price inflation is not sticking at a high level.

If service price inflation still looks sticky and high in the inflation reports next week it means that growth in demand in Australia although running slower is still not well enough contained and requires another tweak higher in the cash rate.

When the RBA interest rate setting committee makes its February decision analyzing the composition of the latest CPI reports will be one factor, but an equally important factor will be trying to assess the state of demand in the Australian economy and whether that is tracking soft enough to batten down inflation. On balance, notwithstanding reports that many households are doing it tough, the economic reports still point to willingness and ability to spend.

At the leading edge of economic activity, spending on housing appeared to step up late last year. The value of new home loan commitments lifted 1.0% m-o-m in November and is up 13.1% y-o-y. Home loan commitments, after falling in the early group of official cash rate increases during 2022, bottomed out in February 2023 and have been lifting strongly since.

Home building approvals also improved late in 2023, rising 1.6% m-o-m in November after a 7.2% lift in October. On the basis of stronger spending on housing, borrowing interest rates are not high enough.

In contrast to the strength in spending on housing, household consumption spending growth is slowing, but the issue is whether it is slowing enough. Retail trade showed a 2.0% m-o-m lift in November, helped by special sales promotions in the month, but the annual growth in retail trade at 2.2% y-o-y sits well below inflation running above 4% y-o-y. November total household spending is up 3.1% y-o-y below inflation, but with spending on services up 6.2% y-o-y keeping pressure on service prices.

What is helping to keep households spending relatively freely is strong employment combined with accelerating growth in wages. The latest December labour force report showed a big fall in total employment, down 65,100 but coming after an upwardly revised and bigger 72,600 increase in November. Part of the December employment fall may have been because of the flooding weather down the East Coast.

In any event, employment still rose 51,700 in the three months ending December 2023 and was up 381,000, or 2.8%, in 2023. Strong employment growth combined with wage growth running at 4.0% y-o-y in Q3 2023 and likely to have pushed higher since are providing support for household spending even as sentiment surveys paint a gloomier picture of households fretting about the high cost of living.

On balance strengthening housing demand, slowing household spending growth, although with a strong edge in spending on services, plus some evidence that the labour market is not quite as tight as it has been leaves the RBA stuck between another rate pause or a rate hike. It will get more information relating to December housing activity, retail sales, inflation and Q4 CPI before the February rate decision and these are likely to determine which way the coin falls.

Whether the decision is a pause or another rate hike in February what is clearer is that demand and inflation readings are still far from weak enough to pave the way for interest rate cuts. That is a story for late 2024 at earliest and could easily delay into 2025.