Australia Rate Bears Start Falling on Their Swords

  • Still premature for hawks to begin celebrating as hike far off
  • Subdued labor market and weak wages see CPI creeping higher

Australia’s bearish economists are losing confidence or outright abandoning their calls for the Reserve Bank of Australia to cut interest rates further as core inflation speeds up.

But hawks shouldn’t start popping champagne corks yet: Rather than shooting higher, consumer prices are more likely to creep forward instead. The upshot is Governor Philip Lowe’s plan to sit still is reinforced by Wednesday’s data.

“We no longer expect interest rates to fall further,” said Paul Dales, chief economist for Australia at Capital Economics Ltd. “If the unemployment rate rose well above 6 percent, then the RBA could still cut rates. But we are not forecasting a rise in the unemployment rate. That all said, price pressures and economic growth are not going to be strong enough to warrant interest rate hikes for a long time.”

Dales changed his call for two cuts this year and now says interest rates are likely to be on hold through the end of 2018.

Read the details of Wednesday’s inflation report here

Australia’s labor market will be central going forward. It has plenty of slack -- reflected in high levels of under-employment and a jobless rate near 6 percent -- and until it tightens and workers feel empowered to seek higher wages, inflation is likely to remain weak. But the global backdrop is improved with major economies in a synchronized upswing that could presage faster inflation.

The problem is that in the U.S. and U.K., for example, jobless rates are already at levels that traditionally would represent full employment and yet wages remain subdued. One theory is the ability of firms to move countries quickly leaves workers fearing for job security without even worrying about salary increases. This may turn out to be the case Down Under, too, where wage growth is already at arecord low.

“It is difficult to get concerned about inflation prospects when wages growth and labor costs remain very well contained,” said Michael Workman, a senior economist at Commonwealth Bank of Australia.

At the same time, however, non-tradables inflation -- which is affected by domestic variables like utilities prices -- advanced 0.9 percent on the quarter and 2.6 percent from a year earlier. Given steeply rising Australian power prices in the offing, the gauge seems likely to climb further.

“This component makes up 65 percent of the weight of the CPI and is composed of the domestic goods and services prices that are not open to competition from imports,” Workman added.

In essence, the gap between Australia’s annual headline and core inflation reflects gasoline prices. Still, the results from Wednesday’s data are in line with the central bank’s expectations: that headline prices would return to the 2 percent to 3 percent target this year and underlying prices would take longer.

For now, the central bank’s two key concerns are the subdued labor market and risks from scorching house prices.

“With these concerns pulling in different directions, we continue to expect no change in the cash rate this year,” said Paul Brennan, chief economist at Citigroup Inc. in Sydney. “Any cash rate increase remains a distant possibility. We pencil in the first rate hike for the fourth quarter of 2018.”

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