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But expect to wait until at least November for rate cuts.
This week has been chock-a-block with central bank monetary policy meetings. The US Federal Reserve (Fed), the Bank of Japan (BOJ), the Bank of England (BoE), the Norges Bank, Swiss National Bank (SNB) and, last-but-not-least, our own Reserve Bank of Australia (RBA) all met during this week and, in all but one instance, confirmed market expectations of their deliberations.
The odd-bank-out was the SNB that unexpectedly cut rates by 25 basis points (bps) placing it as the frontrunner in the easing cycle among major central banks. A sub-2% inflation rate has given the SNB scope to cut the rate to 1.5%, a rate that would be the envy of most borrowers around the world.
The BOJ, while moving their policy rate in-line with market expectations, also achieved a landmark decision, ending the world’s last bastion of negative interest rates. The BOJ lifted their rate to a range of 0% to 0.1%.
The Fed and Bank of England meetings were tamer affairs, with both central banks on hold as expected.
On the home front, the RBA shifted from a tightening bias to a neutral policy stance. While this shift reduced any fears of a rate hike, the RBA refused to give any guidance as to the timing of rate cuts.
Since the RBA’s last hike to 4.35% in November 2023, we have maintained the view that the RBA would keep rates on hold until at least late 2024. We expect to see the market push out its timing of the start of the RBA’s easing cycle from September to November over coming months.
However, the path forward for the RBA is anything but clear. Recently, inflation has largely been caused by excess demand; i.e., excess expenditure.
Monetary policy is quite efficient at dealing with this problem as higher interest rates tend to kill off spending and thereby reduce demand and inflationary pressures. But now we are entering a period of very soft demand – just look at the latest GDP numbers of the December quarter, where the economy grew by just 0.2% and consumer spending almost stalled.
And the outlook for the first half of this year is hardly better. This should make the RBA’s life simpler as the lack of demand pressures on inflation should allow the RBA to cut rates if the economic activity slows too quickly.
Yet, despite weak economic growth, inflationary pressures in the Australian economy remain elevated, particularly in the services sector. The RBA itself has been flagging a key source of upside risk to inflation is the high rate of growth in unit labour costs.
Fundamentally, wage growth is too high given the lack of productivity growth, resulting in cost increases in labour intensive service-sector industries which contributes to sticky and elevated services inflation. Typically, a deterioration in the economic outlook and subsequent rise in unemployment, coupled with abysmal productivity growth, would lead to a sharp moderation in real wage growth.
However, we are seeing and are likely to continue to see persistence in wage increases as a result of: (1) payback in new enterprise bargaining agreements (EBAs) after several years of very weak outcomes; and (2) the focus by the Fair Work Commission on preserving real wages of award workers.
A consequence of these wage outcomes is a breaking of the link between productivity improvements and wage increases, which will keep upward pressure on unit labour costs until later this year. The upshot is that the RBA may need to keep rates on hold for longer, and at a time when the economy could benefit from lower interest rates.