The RBA has made it plain at the first board meeting of 2024 that while the cash rate will be cut at some point, the first move is not imminent. According to the forecasts in the February Statement of Monetary Policy released at the same time as the RBA decision, the cash rate stays at 4.35% through the first half of this year but could be cut to 3.85% by the end of the year if productivity improves and wage growth does not push up too much more.
Essentially, the RBA is pleased with the progress reducing inflation, but still sees more work ahead to get inflation down to its target band 2-3%. Currently, even with the progress reducing inflation through 2023, it is still sitting above 4% y-o-y on all the Q4 CPI measures and that is too high. The forces of supply and demand in the economy are in better balance but demand may need to be battened down further, possibly with further rate hikes to ensure that inflation will believably glide down within target range by late 2025.
RBA Governor, Michelle Bullock, mentioned in the new post-rate decision press conference that for two decades before the push up in inflation of recent years inflation was a non-issue for businesses and households accepted as being in the background around 2% and not a point of concern. Governor Bullock would like to see inflation returning to becoming a non-issue or point of concern. Clearly that is not the case at present where cost of living issues are still prominent concerns.
In terms of what might make inflation less of a concern, it comes down to more progress making sustainably low inflation more likely. The RBA is getting closer to being comfortable that inflation can get down to target. The latest RBA forecasts have CPI inflation coming down to 3.3% y-o-y in June 2024, 3.2% in December 2024, 2.8% in December 2025 and 2.6% in June 2026.
To generate these acceptably lower inflation outcomes, wage growth cannot be much higher than where it was in Q3 2023, 4.0% y-o-y according to the wage price index. The Q4 2023 wage price index will be released next week and the RBA is forecasting 4.1% y-o-y. The RBA has the wage price index holding at 4.1% y-o-y in June 2024 before moderating to 3.7% y-o-y by the end of 2024 and 3.4% by the end of 2025. These moderating wage growth forecasts, however, are consistent with inflation coming down to target only if productivity lifts.
Productivity has fallen over the past year and more. In the latest Q3 2023 GDP report, labour productivity (GDP per hour worked) was down 2.1% y-o-y. The RBA in the latest forecasts assumes that productivity will not have fallen as much as it has through much of 2023 when the Q4 2023 GDP numbers are released in early March. The RBA has labour productivity improving to down 0.5% y-o-y in Q4 2023 before lifting sharply by 3.0% y-o-y in Q2 2024 and settling at growth between 1.1% y-o-y and 1.4% y-o-y from Q4 2024 to Q2 2026.
The sharp lift in productivity forecast by the RBA is possible but is also quite a tall order. Without the sharp lift in productivity the wage growth forecast by the RBA will be too high to allow inflation to come down to target the way it has forecast. It would need wage growth to be lower than forecast to achieve the inflation forecasts.
The RBA needs to see how wage growth and productivity are moving through at least the first and second quarters of this year. If they are moving along as the RBA has forecast, it can be more confident that inflation is likely to come down to target paving the way to start cutting the cash rate.
The need to see peaking wage growth combined with improving productivity means that the release dates of the next two or three quarterly GDP and wage reports (March, June and September for GDP and May, August and November wages) will play a large role determining when the RBA can consider conceivably a first rate cut. The RBA needs to see suitably strong productivity change in Q1 and Q2 as well as contained wage growth of 4.1% y-o-y or less in both quarters.
That could bring September into play for a first rate cut but our view is that it may take at least one quarter longer to meet the productivity and wage growth benchmarks the RBA needs to be certain that inflation is diminishing sustainably towards target. That means December is effectively the first month when the RBA can start cutting the cash rate.
In the meantime, the next reports on wages and productivity out next week and early March respectively must not show too strong wage growth (above 4.1% y-o-y) and too weak productivity (worse than -0.5% y-o-y). That would not only push back the timetable for the first rate cut but would also provide reason for the RBA to remain on the brink of hiking the cash rate again.