In something of a shock, the Reserve Bank (RBA) held interest rates steady earlier this week and, while there is a hotly contested debate about the future path for monetary policy, there is a strong and growing probability that Australia has seen the end of the rate-hiking cycle.
This was only the second pause in what has been an unrelenting cycle, which started in May 2022. The official cash rate is currently 4.1 per cent, a rate that is imposing a huge weight on the Australian economy.
Also by the Kouk:
It is clear, even to RBA governor Phillip Lowe, that inflation is falling, growth is stalling and the unemployment rate is set to rise over the next year. He said as much in his press statement announcing the steady interest rate settings.
Indeed, the economy is slowing at a troubling rate. Annual GDP growth is on track to dip below 1 per cent - roughly half the rate of population growth - which means the average Australian will be worse off in the year ahead. This rarely happens and goes a long way to explaining the miserably weak consumer sentiment levels in the past six months and the severe weakening in retail spending that is the centrepiece of the economic downturn.
The run of economic news is also seeing a steady fall in demand for labour, with job advertisements and vacancies trending down. There is no doubt this will spark a jump in the unemployment rate, as the RBA acknowledges. The only points of debate are how high and how quickly the unemployment rate will rise.
There is little doubt unemployment will hit the RBA target of 4.5 per cent within 12 months, which means around 150,000 people currently employed will be unemployed in 2024. This, along with the strong levels of immigration, will keep wages growth in check.
The key story in the monetary-policy discussion is inflation.
Inflation around the world is falling rapidly. It is nearly zero in China and the slowing in global growth is eating away at any demand pressures that were underpinning the previous upside to inflation.
Commodity prices remain weak, which will feed into weaker inflation over the second half of 2023.
The debate is not “will inflation fall?” Rather, “how quickly will inflation fall?”
The RBA’s latest forecasts suggest inflation will not be within the 2-3 per cent target range until the second half of 2025. This forecast appears extremely pessimistic, given how rapidly inflation is falling and how weak the economy actually is.
Inflation is set to get to the target 12 to 18 months before this.
The two key data points between now and the August RBA Board meeting will be the June labour force figures - due for release on July 20 - and the June quarterly and monthly inflation data - due for release on July 26.
The monthly labour force data can be choppy, meaning occasional large moves on a month-to-month basis. That said, if the June data show a further slowing in employment growth and a further uptick in unemployment, the ‘rates on hold’ narrative will be reinforced for the RBA August meeting.
The inflation data will be hugely important. The monthly ABS data already show annual inflation has fallen from 8.4 per cent in December 2022 to 5.6 per cent in May 2023. Over the first five months of 2023, the annualised inflation rate has been below 3 per cent, a trend that is likely to be reinforced with the June data.
This, together with a further deceleration in the quarterly inflation data, to around 6.25 per cent, will be welcome and confirm the disinflation trend that is clearly unfolding globally and in the domestic economy.
All of this points to a high probability of the RBA holding interest rates steady in August, which will suggest that the peak in official interest rates is in.