MNI INTERVIEW: RBA Needs Low Services Inflation To Limit Hikes

Services inflation will need to ease to bring down the trimmed-mean gauge of price increases and reduce the likelihood that the Reserve Bank of Australia will raise the cash rate twice more in 25 basis-point increments to 4.85%, a former bank economist told MNI.

“I don't know where the help is going to come from to get inflation back to 2.5%,” said Justin Fabo, founder of Antipodean Macro and the RBA’s former head of international financial markets, pointing to April’s 3.4% y/y trimmed mean result. “It’s not housing components, it’s probably not food, it’s probably not administered costs, so I keep coming back to services inflation, which is a labour-cost story.”

Underlying inflation remains persistent despite April’s decline in headline CPI, he said. And while unit labour costs softened slightly in Q4 despite remaining elevated, they could rebound in the March quarter alongside an increase in hours worked, which would weigh on productivity growth and add further pressure on the RBA to continue tightening, he added.

The Australian Bureau of Statistics will release updated National Accounts data on June 3.

Fabo noted markets had trimmed expectations for further rate increases following April’s CPI release and recent labour market data, seeing only one further increase to 4.6%, but he said this was likely a miscalculation. “The labour market numbers look pretty ropey to me, and the core inflation numbers are still really strong.”

Softness in rents over the past couple of months was due to Commonwealth Rent Assistance and is likely temporary, he said.

“That’s going to bounce back, along with new dwelling purchase inflation, which is probably only going to get stronger because of the [Iran] conflict,” he said. “Those two things have a big bearing on trimmed-mean inflation as an anchor for it, so it feels to me like market pricing has got it wrong and will go back up at some point.”

Fabo said his central case remained one to two further hikes, noting that, while the timing of further tightening remains uncertain due to geopolitical risks, he did not believe the current cash rate was sufficiently restrictive. The key uncertainty is whether higher interest rates will have a larger impact on the housing market and broader activity this cycle, eventually dragging down core inflation, he argued.

LABOUR MARKET

However, Fabo said a sharper deterioration in labour market conditions would likely prompt the RBA to deliver only one additional increase before pausing indefinitely. 

The RBA’s forecasts already imply a gradual rise in unemployment alongside additional tightening, meaning a materially weaker labour market would undermine the case for further hikes. “If the unemployment rate starts going up faster than their forecasts assume, then you don’t get any more hikes,” he said. 

“We’ve had one unemployment rate number which was pretty high relative to their forecast. I think at least some of that is noise in the numbers, so we need another couple of readings to get a better feel for the labour market."

For now, it would be reasonable to expect hiring to pause temporarily while geopolitical uncertainty persists. “If the conflict resolves itself reasonably soon and there’s a bit more certainty for businesses, I don’t see why we don’t go back to reasonably okay rates of hiring,” he added. “The unemployment rate might drift a little higher, but not too quickly.”

Fabo correctly noted in February that persistent labour market strength would lead to tightening this year. (See MNI INTERVIEW: March RBA Hike Possible As Jobs Market Tightens)