Navigating Australia's Disinflationary Path: RBA Rates, Labor Market, and Inflation Outlook
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Australia: How to ride a bumpy disinflationary path
Australia's growth outlook has cooled off, but the labour market remains too tight and the decline in inflation has been primarily due to base effects. We disagree with markets' expectations that we have seen the peak in RBA rates, and expect at least one more hike. This should help a recovery in the undervalued (in the short- and medium-term) Aussie dollar.
After two months of 'no-change', the market has decided that the Reserve Bank of Australia (RBA) has finished hiking rates. We disagree. There has been only a modest slowdown in the economy, and most of the decline in inflation so far owes to base effects which are turning less helpful, while the run-rate for month-on-month inflation remains much higher than is consistent with the RBA’s inflation target. We expect at least one more hike, possibly in September or maybe waiting for the quarterly inflation numbers which will be known by the November meeting, and quite possibly two. That would take the cash rate target to 4.35% with an upper risk of 4.6%.
If we are right that the US Fed has finished tightening, then this could see some outperformance of the AUD into year-end. AUD’s sensitivity to pro-cyclical trades and the shape of the yield curve, as well as its pronounced undervaluation, put it in a good position to potentially outpace other G10 peers in a multi-quarter USD decline.
The macro picture: Labour market remains tight
GDP growth in Australia has slowed every quarter since the third quarter of 2022, and looks set to deliver another weak quarter of growth in the second quarter of 2023. NowCasting estimates are pointing to only about a 0.2% quarter-on-quarter increase, and 1.5% year-on-year annual growth rate in the second quarter.
Australian GDP projections
This suggests that the RBA’s rate tightening is indeed working, on top of the external factors weighing on growth (weak China re-opening, US and EU slowdown).
But on many measures, the Australian economy remains robust, and this remains a concern when we dig into the inflation data and see that on some measures (admittedly not all) inflation is still running quite strong.
In particular, Australia’s labour market shows only limited signs of slowdown. At 3.5%, the unemployment rate is close to its all-time low of 3.4% in October last year. And almost all of the jobs that have been created over that time have been full-time jobs, with commensurately higher weekly earnings, benefits and security than part-time jobs. That means household spending power is being supported. The consequence of this is that wages growth, though only measured quarterly, and with long lags, remains, according to the RBA’s own anecdotes, on an upward path. And this will help keep service sector inflation higher than would ideally be the case.
Wages, unemployment and inflation in Australia
