Australia's Uncertain Path: Deciphering Inflation, Rate Hikes, and Market Confusion

Australia: Why markets may be pricing in too much tightening

Australia’s economy is slowing, though not enough to quell inflation fears. Inflation itself is falling, though the pace of decline has been erratic and the labour market remains robust. Amidst all of this, the Reserve Bank of Australia has been hiking rates though is struggling to get its message across about the likely path from here.

 

Guidance has sometimes been inconsistent

Markets have been taken on quite a ride in recent months. Firstly, the RBA noted at its February 2023 meeting that inflation was unlikely to fall into its target range until 2025. We don’t agree. But notwithstanding that, there seemed to be information contained in that statement that rates would stay higher for longer.

Then there was the change to the policy statement in March moving from “further rate hikes” to “further tightening”, which seemed to suggest multiple planned hikes had dwindled to just one and was followed by a pause in policy in April. Markets smelled a peak in rates at 3.6%.

 

 

Then, despite further falls in inflation, the RBA hiked again in May and held the door open to further hikes (the previous singular rate hike hint seems to have been erroneous, misinterpreted, or both), and subsequent commentary emphasised the risks to rising unit labour costs and low productivity.

That was then followed by a higher-than-anticipated wage price index for 1Q23, a softer-than-expected labour release for April, but a pickup in monthly inflation data. Markets were divided, but most thought the RBA would leave rates unchanged in June. They didn’t, and hiked to 4.1%, with a hint that further hikes were going to be data-dependent.

 

 

Most recently, the May labour data has strengthened unexpectedly again, raising doubts about the whole slowdown story and putting the RBA back under tightening pressure.

Markets are still pricing in further hikes, but it doesn’t feel like they have a strong grasp on what is really going on, or where we are going from here. Admittedly, the macro data has been very erratic. But this hasn’t been helped by official guidance, which has not been very consistent. This note will try to make some sense of what is a very cloudy backdrop. But the reality is that the outlook remains extremely uncertain.

 

Productivity is cyclical

 

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