Sticky inflation to keep RBA @ 4.25%

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Today’s Q4 retail trade release had a little something for everyone – however on balance I disagree that it makes a case for the RBA to ease their policy rate by 25bps, to 4%, at their February meeting.

The main reason I am unconvinced is I assess the inflation pulse as running ~2.5%,  see growth as around trend, and can find no global data or events that mean the RBA must downgrade their global growth or financial market assessments.

Global data and financial markets have arguably improved since the RBA’s December meeting — when they eased policy 25bps, but described it as a close call.

The key to my outlook is my assessment of inflation. If I believed that inflation was truly running at ~2%y/y pace, I’d favour a cut. A key reason to doubt this is captured by the above chart. It shows the (implied) retail price deflator, excluding food prices.  This measure of inflation shows that Q4 retail price inflation (ex food) was 0.44%q/q, (down ~10bps from 0.55%q/q in Q3).  Taking the two quarters together, this suggests that underlying retail price inflation H2’11 was running ~1.8%y/y.

The median spread between the retail price deflator (ex food) and trimmed mean CPI has been ~60bps since Q3’01 (the post GST period), so that means that it’s probably the case that core inflation pressures were running around 2.5%y/y in H2’11, and not the 2%y/y pace that you’d get if you simply annualised the Q3 and Q4 Trimmed Mean CPI prints.

My view on inflation in 2011 is that CPI was biased up by supply shocks moving the AS schedule to the left in H1’11, and has now been biased down as the AS schedule has moved back to the right.  The true underlying pace is ~2.5%, and it has been there for about the last six quarters.

So current inflation pressures are just where the RBA wants them.

As for the outlook, the economy looks to be presently running around trend – the unemployment rate is steady around 5.25% and has been there for some time.

Various labour market indicators are consistent with a steady unemployment rate – and if anything, today’s 6% increase in the Jan ANZ job ads report suggests that the unemployment rate is more likely to decline than rise over the next few quarters.

If the recent pickup in global growth is sustained, it’s more likely than not that the unemployment rate will begin declining once again. If that occurs, there’s only ~20bps of padding before the unemployment rate drops below 5% – a rate at which inflation typically picks up.

That means that the RBA is just as likely to be revising up their inflation forecast as revising it down in 2012. And recall that assuming a 4.5% policy rate, the RBA forecast that inflation would be in the top half of their target range in H2’13 (when policy has had it’s full impact).

My best guess is that the RBA will hold their overnight policy rate steady at 4.25% tomorrow, and that they’ll publish growth and inflation forecasts that are substantially unchanged in their Q1 SOMP – released this Friday (10 Feb).

I think the RBA is waiting for more information – and are willing to ease further only once they can see evidence that it is required.


  1. I agree. Domestic non-tradable inflation (mostly services) is still here and it’s well above the RBA target band. Imported goods are cheaper and will get cheaper. On balance we are spot in the middle of the band, but we just had 2 cuts. World markets are recovering. The RBA can afford to wait for more data and keep cuts for later if needed. Only problem is that the AUD will go to 1.10 if they do not cut as expected.

  2. Very good rationale, you’ve almost switched me to your point of view.

    Where does housing fit into this? I reckon RBA will cut on housing…house prices falling, new home sales yet to recover, building approvals dropping like a stone – this will have a marked effect on economic activity if not reversed. Only way to reverse is lower interest rates…

    1. They seem to think housing is stabilising – a view which i share. But if it starts creaking again, i agree that they will cut.

      1. Is 425 high enough to avoid zero bound? In extreme case that unemployment spikes, housing will almost certainly get hit do they have enough conventional ammo?

      2. Even worse we don’t have super safes for unconventional monetary policy. That would squeeze banks pursuit of liquids.

        1. It would have to be done by the fiscal authority. Not that there is much difference between fiscal and monetary policy at the ZLB.

          Sent from my iPad

      3. Oh I’m not that bearish.

        Just pointing out that unemployment and property are highly correlated.

        But if unemployment spikes, housing will have serious collapse as will commercial real estate.

      4. They could buy foreign govies, aaa rmbs, semis. I’m not sure if they are legally permitted to do this.

        Or they could just level target NGDP. :P

        So they will have options.

        1. An ngdp target is a policy rule, not an implementation tool.

          I expect that the rba will buy bank debt, if the worst happens.

          Sent from my iPad

      5. Yes re rule vs tool. I tend to think level NGDP targeting would amplify monetary response function vs quasi (asymmetric) Taylor rules.

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