MNI RBA WATCH: Jobs Caution, Inflation Set Up Rates Coin Flip

The Reserve Bank of Australia's decision to raise or pause the cash rate at the May 2 board meeting will be a coin flip, with the Bank wary of triggering labour market pain as it tackles inflation persistently well over the 2-3% target.

A further pause – the RBA snapped a chain of 10 consecutive increases at its April 4 meeting, leaving rates at 3.6% (See: MNI RBA WATCH: Rates on Hold, Bank Charts Cautious Path) – would play into the Bank’s aspiration of keeping unemployment between 4-4.5% while still returning inflation to target by 2025. (see: MNI POLICY: RBA Eyes Mid-25 Target Return, Unemployment 4-4.5%). But a 25bp increase would placate some of the Bank’s critics and address the issue of sticky inflation, especially among non-tradables.

While CPI for the March quarter printed below market expectations – trimmed mean CPI rose 1.2% q/q compared to the expected 1.4% – annual CPI proved sticky, printing at 7%, above the expected 6.9%. While the market expects no change next week, bank analysts are divided and the overnight index swap rate has nixed the chance of a rate cut by year's end, illustrating the growing view that rates will hold elevated for longer and the cash rate has likely reached its peak.

RBA VIEW

Governor Philip Lowe has said further increases were possible following April’s pause, with the rental market, high immigration and electricity price growth noted as key issues that could lead to more tightening.

Housing rental inflation also remains elevated, though MNI understands that an internal debate among RBA economists is underway on how exactly monetary policy – and further hikes – could impact rent.

Population growth has also surprised the RBA, which had expected a slower return to normal. The Federal Government this week unveiled reforms to Australia’s immigration system, though the impact on net population inflows has not been determined.

Lowe also expects further energy price rises this year, targeting a 15% y/y increase by year’s end, up from 2022’s 12% gain.

WAGES & LABOUR

The goal to maintain high levels of employment – which currently sits at 3.5% – drove the RBA’s thinking on rates in April. The Bank said its pause was consistent with its desire to assess the full impact of the swift pace of past rises, but it also wants to see what further wage gains a tight labour market could produce before higher rates stoke unemployment.

To date, Australia has not experienced rapid wage inflation as noted overseas. But this could change as various state Labor governments move forward with public sector wage increases that had been curtailed during the pandemic years. The Fair Work Commission could also lift the country's minimum wage by mid-year, with the country's peak union body pushing for a 7% increase.

Former RBA staffers have told MNI the Reserve's pauses are overly optimistic and that the Bank is walking a fine line that could imbed inflation expectations. Some believe the cash rate must rise above 4% to bring down inflation over a reasonable timeframe.

More on the Reserve’s thinking will be known when Governor Lowe delivers a speech at a Board dinner following the May 2 decision. An updated set of economic forecasts will also be published in the May Statement on Monetary Policy next Friday.