Dr Brendan Rynne, KPMG Chief Economist, comments on RBA rate decision
As anticipated, the Reserve Bank of Australia board today left the cash rate unchanged at 0.1 percent, despite increasing noise about an impending uptick in inflation and wages.
KPMG believes the RBA’s strong forward guidance that the cash rate will remain unchanged for the short term is now being more accepted by the market – despite the fact the inflation drums are beating louder than earlier in the year, when 10-year bond rates rose to nearly 1.9 percent at the end of February. Since then the yield curve has flattened with 10-year bonds retreating, trading between 1.5 percent and 1.6 percent this week.
It has taken a while, but the market has now switched onto the same facts that RBA economists have been considering in giving their forward guidance. These include the fact that the impending spike in inflation in the June quarter 2021 is driven more around statistics, namely the concept of ‘base effects’, than by market outcomes. Simply, the -0.3 percent inflation recorded in the June quarter 2020 will fall out of the annual inflation calculation, resulting in a double jump in inflation for the June quarter 2021.
The more tangible impacts driving inflation, and then by default the cash rate, include labour market capacity, global supply chains, and spikes in aggregate demand due to fiscal stimulus spending.
Australia’s labour market still contains enough spare capacity – notwithstanding the fact that pockets in the labour market are finding it difficult to attract specialist staff – that immediate pressure on wages remains muted. The current combined levels of unemployment and underemployment are still around similar levels experienced during the past 5 years – a period when inflation consistently undershot the RBA 2-3 percent target inflation range. Both the RBA and the Commonwealth Treasury have recently examined at the level of unemployment necessary for inflation to be triggered (the non-accelerating rate of inflation, NAIRU) and found it is likely to be lower than previously thought. It is now believed to be about 4.5 percent (compared to 5 percent historical estimates).
While the pandemic has put pressure on global supply chains – and as a small open-economy Australia is highly dependent on imports and therefore the efficient functioning of these supply chains – there has not been a sustained disruption to the production of goods. The initial disruption to goods supply while countries shut down their businesses mostly finished by the middle of 2020, although the higher cost of transport and shipping has continued to play a disrupting role to global supply chains. But while important, transport costs tend to be only a small fraction of the final price of imported goods, and therefore while still additive to inflation it is less so than if goods supply was permanently disrupted.
There has been concern that government stimulus the world over, including Australia, would prime aggregate demand to such levels that inflation would re-emerge as a moderating factor. However, what has become more apparent is that most of the pandemic-induced spending is in the form of income transfers rather than immediate spending on goods. Infrastructure spending has certainly increased but this spending takes years to come online and is often spread out over five to 10 years.
These factors, among others, are now sinking into the market and there appears to be a tacit acceptance that the inflation genie, while edging up the side of the bottle, is not likely to burst out of the top and make a run for it. Of course things can change, but as things stand, we believe that official interest rates will be kept lower for longer but retail market rates offered by lenders will tick-up a little, reflecting higher wholesale market costs (for instance, as the Term Funding Facility rolls off).
Tags Interest rates