The Reserve Bank wears its badge as an inflation-targeting central bank with pride.
Its mandate since joining the other big central banks targeting inflation in the early 1990s has been straightforward: “Maintain a stable currency, full employment, and the economic prosperity and welfare of the Australian people.”
“It does this by setting the cash rate to meet an agreed medium-term inflation target, working to maintain a strong financial system and efficient payments system, and issuing the nation’s banknotes,” the RBA says of itself on its webpage.
Sure, the financial system has fostered misconduct on an industrial scale that’s been exposed at a banking royal commission, but the system itself is sound and the banks are well capitalised.
Which brings us to the more problematic use of the cash rate “meeting an agreed medium-term” inflation target. That target sees inflation corralled in a band of 2 to 3 per cent.
This Wednesday should see the third anniversary of core inflation — that’s the less volatile measure preferred by the RBA — stuck under 2 per cent.
Headline inflation — the broader measure including food and fuel and most prominently reported — has been below 2 per cent since late 2014, apart from two quarters where it popped up and down rather quickly.
Of course, the RBA can argue the toss on what the “medium term” or “across the cycle” means, but 12 straight quarterly misses suggests a trend has been established and an adjustment could be considered.
For the record, the consensus call for first quarter inflation is headline inflation falling from 1.8 per cent to 1.5 per cent. Core inflation is also expected to be lower at 1.7 per cent.
As NAB’s economics team noted, that is likely to see the RBA push its forecast return to the target range out to the second quarter of 2020.
In other words, setting sail for its fifth year outside the target.
Inflation: The good, the bad and the ugly
For the RBA and most other central banks, inflation holding at around 2 to 3 per cent is the sweet spot. Targets vary, but it’s thereabout.
Low inflation may seem like a blessing for those who dealt with inflation stuck above 10 per cent through the 70s and much of the 80s, or the spike above 5 per cent at the start of the millennium, but it is a big part of the current regime of low wage growth and an economy not meeting its full potential.
The high inflation of yesteryear went hand-in-hand with wages break-outs as workers chased their disappearing purchasing power. Higher rates of unemployment weren’t far behind. So yes, high inflation is bad.
But when inflation is too low for too long, wages stagnate as businesses stuck with low prices are not inclined to crimp their margins and pay their workers more.
At the more extreme and uglier end is deflation. It leads to lower spending as consumers look for lower and lower prices due to their thinner and thinner pay packets.
Pretty soon the economy slows and you guessed it, businesses finding conditions tough either want to (a) reduce real wages or (b) shed staff. Generally, they go for option (b), according to the RBA’s handy explainer.
“This is because businesses that need to decrease their real wages usually choose to allow their nominal wages to grow at a rate that is below the general rate of inflation, and if inflation is very low this is more difficult to do,” the RBA warns.
So far the RBA has not had to worry too much about its inability to hit a pretty broad target for three years. Job growth has been rattling along at a fair clip and economic growth, while not robust, is still at least growing.
RBA tension mounting
However, there appears to be frustration mounting within the RBA, if nothing else due to its increasing number of critics calling for a rate cut to kick the economy up a gear.
The RBA has acknowledged the “tension” between strong jobs growth and weak GDP growth and now has laid down its conditions for a rate cut.
At the head of the list is inflation remaining stuck below 2 per cent and unemployment trending higher.
Westpac says it is a given the “inflation condition” for a cut will be met.
“Core inflation is to remain well below the bottom of the RBA target band as moderating housing costs hold back modest inflationary pressures elsewhere,” Westpac’s Justin Smirk said.
“Overlay a competitive deflationary pressure in consumer goods and it is hard to see core inflation breaking much higher any time soon.”
Unemployment ticking the rate cut box may be just a matter of time too.
The recently released March jobs figures did show unemployment ticking up a notch.
Perhaps that was just statistical noise, but the key point is unemployment cannot seem to get much under 5 per cent, as long as population growth is strong and the participation rate is high. That means wages are unlikely to rise much any time soon either.
Cyclical jobs disappearing
Keeping in mind the RBA’s conditions for a rate cut, as well as the tensions between employment and GDP growth, Westpac has broken down employment by various industries.
It found the jobs growth has been supported by “non-cyclical” areas such as public administration, education and training, and health care and utilities.
Non-cyclical jobs as a proportion of the workforce have risen by 4 per cent to around 32 per cent over the past decade. Put another way, that’s an extra 510,000 jobs in terms of today’s workforce.
Importantly, the momentum is building, with the growth rate picking up in recent years. The opposite is true for cyclical jobs.
The cyclical group — including the big employers in construction, manufacturing, transport, finance and tourism — has seen its share shrink by 4 per cent.
“As noted by the RBA, overall momentum in the jobs market has held fairly steady over the last 18 months despite the slowdown in economic growth,” Westpac said.
“However, momentum in the ‘cyclical’ sectors has slowed markedly from 2.9 per cent in the six months to February 2018 to -0.4 per cent in the six months to February 2019.
“Our analysis points to a marked slowdown in jobs growth already being well underway in the cyclical sectors of the economy.”
That would mean the other condition for a cut is likely to be met.
Markets deliver mixed Easter message
Ahead of the Easter break, Wall Street ground higher while the global basket of stocks fell.
The S&P500 was buoyed by strong retail sales and to an extent a tailwind from much better than expected Chinese data.
Europe was a bit more introspective, with another batch of weak German and French manufacturing surveys weighing on sentiment.
Before dashing off for their break, futures traders bid up the ASX, which should see a positive start to another short week’s work.
Markets on Thursday’s close:
- ASX SPI 200 futures +0.4PC at 6,236, ASX 200 (Friday’s close) flat at 6,260
- AUD: 71.5 US cents, 63.5 euro cents, 55.9 British pence, 80.0 Japanese yen, $NZ1.07
- US: Dow Jones +0.4pc at 26,560, S&P500 +0.2pc at 2,905, NASDAQ flatc at 7,998
- Europe: FTSE -0.2pc at 7,460, DAX +0.6pc at 12,222, EuroStoxx50 flat at 3,499
- Commodities: Brent oil flat at $US71.97/barrel, Gold +0.1pc at $US1,275/ounce, Iron ore $US92.96/tonne
The big driver in sentiment this week will be a deluge of profits from some of the US’s biggest and most important companies.
Facebook, Amazon, Coca Cola, Microsoft and Exxon Mobil are just four of 155 companies — representing $US9 trillion in value, or more than a third of the index — reporting this week.
It’s not looking promising. Refinitiv data shows analysts expect profits to be down 1.7 per cent — the first year-over-year earnings decline since 2016.
“The focus is going to continue to be on earnings and what the message is and so far the message hasn’t been that great,” Butcher Joseph Asset Management’s chief Ken Polcari told Reuters.
“If they continue to be what they are, these kinds of lacklustre reports, the market is going to get exhausted and it is going to back off. It is going to be an important week just for direction.”
The key economic data is dropped at the end of the week, with an expectation US GDP growth over the year has slowed from a pedestrian 2.2 per cent to a rather lame 1.8 per cent in the first quarter.
|Inflation||Headline inflation 0.2pc QoQ & 1.5pc YoY|
|Anzac Day||Public holiday|
|Import/Export prices||Q1: Solid 3.5pc rise in export prices, while imports up just 0.5pc|
|US: New home sales||Mar: Housing market has been getting softer|
|EU: Consumer confidence||Apr: Weak, but has steadied|
|US: House prices||Feb: Slowing|
|US: Durable goods orders||Mar: A proxy for business investment. Should rebound after Feb’s fall, but still soft|
|US: GDP||Q1: Likely to slow to 1.8pc YoY from 2.2pc in Q4 2018|
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