When economic data are released, they relate to periods weeks or months earlier. Later this week the June labour force report will be released reflecting a survey conducted in the first two weeks of June. Beyond the six-week reporting lag in the June labour force report, it was decisions made in May and earlier by employers that generated the June data.
Moving ahead three weeks to early August, the RBA will use the information in the June Labour force, together with many other pieces of information, some with even longer reporting lags, to inform its next monetary policy decision.
Based on the “latest economic readings”, the RBA board is widely expected to deliver another 50bps rate hike, taking the cash rate up to 1.85%. Whatever the decision, the influence of this latest rate hike will pan out over many months – up to 15 months according to some research, much less according to others. Monetary policy change takes effect with a notoriously long and variable lag.
Data collection lags and policy implementation lags mean that whenever monetary policy changes, the economic outcome from the changes is never precisely predictable. The lags mean that in the best of circumstances, the risks are always high of policy change being too late, too little, or too much.
The first cash rate hike by the RBA in May was delivered too late, arguably about a year too late. Data lags played a part in delaying the decision. The data showing the strength of the economic growth rebound from the mid-2020 covid recession only started to become clear cut in the first half of 2021.
Back in the first half of 2020, when lockdowns were the only effective defence against covid and the economy tumbled into deep recession, the RBA responded with “emergency” rate cuts. Subsequently, the economy lifted at record pace and power on the combination of government emergency payments and emergency-low interest rates. The extraordinary extent of the economic growth take-off showed in extraordinarily strong Q3 and Q4 GDP, the latter reported in March 2021. By then, the economy had been growing at well above-trend growth since mid-2020.
Based on strong data reports, a case to reverse the emergency rate cuts delivered in 2020 existed in the early months of 2021. But the case was clouded by potential return to weak economic conditions from new waves of covid infection as well as belief at the RBA that its 2-3% inflation target would be met for the foreseeable future because wage growth, based on the quarterly wage price index, remained low.
The wage price index showed mildly accelerating although still low annual wage growth around 2% y-o-y throughout 2021. It was the key piece of information that led the RBA to believe that it could allow the economy to run at well above trend growth with the unemployment rate stretching down to levels not seen since the early 1970s. During the second half of 2021, however, business surveys were starting to show that labour shortages were becoming a problem. Stories of wage increases to attract workers to industries suffering acute shortages became common.
During the first half of 2022, it has become clear that the wage price index will pick up pace. The quarterly change in the wage price index was 0.7% q-o-q in both Q4 2021 and Q1 2022. While the wage price index showed only 2.4% y-o-y change in Q1 2022 it has been annualising above 2.8% since Q3 2021 and will soon push well above 3%.
The Minimum Wage lift of 5.2% took effect from July 1st and the 4.6% lift for higher-paid related awards will take effect in stages through Q3 2022 and early Q4. The quarterly wage price index readings reflecting these changes will not be published until mid-November for the Q3 wage price index and mid-February 2023 for the Q4 wage price index. Those pesky data lags are well and truly in play again. If the RBA waits for the data showing 3.5% or more annual wage lift (probably occurring around now), it would be reacting in its March policy meeting next year!
The RBA has realised belatedly that it has been blind-sided by the power of Australia’s economic recovery and the wage and inflation consequences that go with that. It is now rushing to catch up, trying to raise the cash rate quickly to what it currently perceives as a more neutral interest rate setting around 2.50%.
Moving interest rates up quickly runs the risk of causing sudden and potentially large spending changes by Australia’s heavily indebted household sector. It would be helpful if those changes were obvious instantly allowing the RBA to change its policy course. Unfortunately, data lags mean that the damage will be done several months before it can be seen in economic reports.
The RBA is saying that it will conduct the current monetary tightening phase taking account of the latest economic information. The problem is, because of lags, the latest economic information will continue to show economic strength, rising wages and rising inflation well after the actual inflection to softer outcomes. Data lags so often prove lethal convincing policymakers that the economy is still weakening when it has turned and vice versa that a strengthening economy is continuing to overheat when it has started to soften.
The risk is increasing of the RBA pushing up its cash rate too high too quickly. We expect, reluctantly, that the RBA will hike the cash rate 50bps to 1.85% at its August policy meeting but feel that 25bps or even a pause would be better options.