On Wednesday and Thursday this week two data releases will influence what the RBA does next with the cash rate. At the next RBA policy meeting in early June and in the interest rate setting meetings for several months beyond the two options that the RBA has are to leave the cash rate on hold at 3.85% or to lift it higher. Essentially, annual CPI inflation remains too high whether on the March monthly 6.3% y-o-y or the Q1 7.0% y-o-y and while it is coming down likely progress towards 2-3% y-o-y is an unacceptably long 2 years+ affair. At the same time, the tight labour market is accelerating annual wage growth to a forecast (hoped for) peak of 4.0% y-o-y later this year which would be on the boundary of making containing inflation a more elongated affair.
While fighting inflation and the wage growth that goes with that task remains such a knife-edge business the RBA has little option but to retain a bias to hike the cash rate further. The RBA’s latest economic forecasts show CPI inflation slow to return to 2-3% target band eventually getting down to 3.0% in mid-2025. The RBA’s forecasts also show annual growth in the wage price index peaking at 4.0% y-o-y at the end of 2023 and then slowly moderating to 3.7% by mid-2025.
Rough rule of thumb, if data releases over coming months relating to demand, the labour market, wage growth and inflation are consistent with these latest forecasts, the RBA may need to hike the cash rate once more and that will probably be the peak for this cycle. Data reports indicating a need for the RBA to lower its economic forecasts point to cash rate staying on pause at 3.85%, while data pointing to a need for the RBA to revise upwards its forecasts point to two or more rate hikes still to come.
This is where the two data releases referred to earlier come in to play. The Q1 wage price index report on Wednesday is expected to show an increase around 0.9% q-o-q which would lift annual wage growth to 3.6% y-o-y from 3.3% in Q4 2022. An outcome as expected would leave the RBA’s latest forecast of wage growth of 3.8% y-o-y in Q2 this year and 4.0% in Q4 still in reach, but only just.
The 2023 minimum wage case is approaching with calls for compensation for 7% inflation. The 15% pay increase in the age care sector will be delivered from July1. There is an open question of what comes next in public sector pay settlements in New South Wales after the scrapping of the pay cap by the new State Government and there is the upward pressure on wages from the generally tight labour market.
On this last point of the tight labour market, the latest labour force report for April is out on Thursday. Both the February and March reports were very strong with employment growth above 50,000 in each month and the unemployment rate down at a half-century low 3.5%. The RBA’s latest labour force forecasts are that annual growth in employment slows from 3.1% y-o-y in March to 2.5% in June and 1.6% in December while the unemployment rate lifts to 3.6% in June and 4.0% in December. That implies monthly employment growth averaging around 13,000 over the remaining 9 months of this year.
These signs of easing labour market conditions contained in the RBA’s forecasts are essential if annual wage growth has any hope of peaking at 4% at the end of this year and more importantly starting to show moderating growth in 2024 and the first half of 2025.
On Thursday, the April labour force report is expected to show an increase in employment of around 25,000 and the unemployment rate still down at 3.5% presenting a flag for another RBA rate hike and probably soon.
The Federal Budget brought down last week has some modest influence on the RBA cash rate outlook too. The Treasurer and Treasury contend that the main welfare spending initiatives totaling $A15 billion over four years will not add to inflation pressure and will act to reduce or limit increases in some CPI components. That is why in Treasury’s economic forecasts they have CPI inflation coming down a little further than the RBA to 3.25% in June 2024 (RBA forecast 3.6%) and 2.75% in June 2025 (RBA 3.0%). Also, Treasury while forecasting an identical annual wage growth peak at 4.0%, it is later in June 2024 and decelerates more sharply than the RBA is forecasting to 3.25% in June 2025.
Our view is that the additional welfare spending while well-targeted will add to demand. Low-income welfare recipients tend to have a high propensity to spend from additional income. Almost all of the additional welfare spending in the Budget will be spent rather than saved by recipients.
Also, the welfare package was only part-funded by spending cuts or tax increases in the Budget. The projected Budget bottom line bouncing to small surplus before returning to deficit plus forecasts that government spending will expand in real (after inflation) terms as a percentage of GDP over the next four years also indicate a Budget boosting rather than leaning against demand growth pressuring inflation.
The influence of the Budget priming rather than reducing demand adds to questions about Treasury’s wage and inflation forecasts. What some of the budget initiatives do to contain CPI component growth over the next year or so should be compensated in the forecasts with an addition to those components’ contribution to inflation down the track – the base effect.
Also, given the long lags between a tight labour market generating faster wage growth it seems unlikely that wage growth decelerates quite as fast and quickly as Treasury is forecasting. A similar criticism could be levelled at the RBA’s latest forecasts although the wage growth deceleration they see occurring in 2024 and early 2025 is much less pronounced and more credible than Treasury’s forecasts.
The litmus test for both the RBA’s and Treasury’s wage and inflation forecasts however is how the tightness in the labour market and wage growth shows in the wage and labour force data. The data this week will need to come in as expected or weaker just to allow the RBA to pause at its June meeting. Strong-side reports place the RBA’s latest forecasts out of reach requiring more rate hikes.