A look at similar countries overseas might show the possible path the RBA will have the head down. (Source: Yahoo Finance)
When the ABS released the latest quarterly inflation figures last month, it immediately shattered hopes of a rate cut this year, as both headline and trimmed mean inflation came in hotter than the market and the Reserve Bank were expecting.
As of the RBA’s latest forecasts, the expectation was for the trimmed mean rate of inflation to sit at around 2.65 per cent. In reality it came in significantly higher at 3.0 per cent.
This chart below illustrates the scale of the forecasting miss and the scale of the re-acceleration of underlying inflation pressures compared with what the RBA had expected.
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Amidst this hotter than expected rate of inflation, several major banks shelved their rate cut calls, with the Commonwealth Bank going as far as to call the end of the current cutting cycle.
Unfortunately, the resurgence in inflation is increasingly broad based, with prices pressures in both goods and services now seen re-accelerating.
(Source: ABS)
In and of itself, resurgent inflation well above their forecast range is challenging for the RBA as it attempts to both fight inflation and offer a degree of support for the economy.
Unfortunately for the RBA, there is another dimension that adds significantly to their already difficult task. And that’s the deteriorating labour market.
Since the nation’s unemployment rate bottomed out in October 2022, unemployment has risen by 1.1 percentage points from 3.4 per cent to 4.5 per cent. It had been a relatively slow grind higher, but since the data for November last year the rise has accelerated somewhat, with unemployment rising by 0.6 percentage points since.
(Source: ABS)
While there have been several instances of falling numbers of jobs on a monthly basis, the rise in unemployment as a trend has not been driven by a net loss of jobs as one might expect.
It has instead come about due to the labour force expanding faster than the economy can currently create new jobs in net terms.
For example, since the end of January, the economy has created 86,900 new jobs, which at first glance is not an awful figure.
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Once it’s put into context with the level of employment growth required for a stable unemployment rate, it falls well behind the 204,500 jobs required, assuming a stable proportion of the working age population remains in the labour force.
The official mandate of the RBA is:
“to contribute to the stability of the currency, full employment, and the economic prosperity and welfare of the Australian people.”
In the years since the RBA first set it’s inflation target of 2 per cent to 3 per cent annually in 1993, it has not been confronted with a sustained resurgence in inflation and a significant rise in unemployment at the same time.
The big question for Governor Michele Bullock and the RBA Board is what do they do if uncomfortably high inflation remains entrenched, while unemployment continues to rise.
On this there is no hard guide, no concrete standard that tells the Reserve Bank whether they should prioritise containing inflation or attempting to support the labour market.
Currently economists, the major banks and the market are removing rate cuts from their outlook, with some believing the rate cut cycle is already over and the market currently pricing in one more toward the middle of next year.
But if unemployment was to rise significantly and continue on a concerning upward trend, pressure would mount on the Reserve Bank to cut rates, regardless of inflationary pressures.
There is also the question of a potential serious economic downturn or perhaps even a recession, how would that factor into the balancing of the various elements of the RBA’s mandate?
It would take a very brave RBA Governor to keep rates steady as jobs were lost and the economy fell into a recession.
We can perhaps draw some insight on the issue from the actions of the Bank of Canada (BOC), the Canadian equivalent of the RBA.
With annual core inflation currently at 2.8 per cent, significantly higher than the desired 2 per cent of the BOC’s target midpoint, Canada faces major resurgent inflation issues of its own.
Yet that hasn’t stopped the BOC from cutting interest rates.
(Source: Bank of Canada)
Amidst a 2.3 percentage point rise in unemployment since it’s cycle lows in July 2022, the Bank of Canada has made three 0.25 percentage points cut to its cash rate despite resurgent inflation.
In the latest instance last week, the BOC cut rates despite core inflation being 0.8 percentage points above its targeted midpoint.
Currently the Australian economy is in need of a positive catalyst, something that will boost the fortunes of the labour market, but at the same time not put significant upward pressure on inflation.
At this point there isn’t one expected on the horizon.
On the other hand, government could once again take to driving employment growth with government funded jobs, but with various states currently pursuing budget repair, the heavy lifting would have to increasingly be done by the federal government.
Ultimately, if the economy continues on the current path the Australian people face some challenges ahead and the RBA would face its own trial in choosing what it sees as the lesser of two evils.
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