GSFM’s Stephen Miller has outlined the challenging “last mile” on the path to disinflation even as a number of central banks will be contemplating their next steps in policy meetings in March.
On 7 March, the European Central Bank (ECB) meeting resulted in a hold of 4 per cent, largely in line with forecasts, with the ground seemingly set for a rate cut in June. In the subsequent press conference, ECB president Christine Lagarde outlined the central bank was “not sufficiently confident [to cut rates yet]”, although it remained confident of a return to inflation close to target.
The Federal Reserve (Fed), meanwhile, is scheduled to meet on 19–20 March, with another hold on the cards. Fed chair Jerome Powell previously flagged it was “not far” from having the confidence to cut the policy rate in a congressional testimony in February.
Closer to home, the board meeting of Reserve Bank of Australia (RBA) is slated for 18–19 March while it faces a “challenging environment” in trying to negotiate a dual mandate of containing inflation and minimising unemployment, according to Miller.
“In Australia, the December quarter national accounts release contained few surprises but emphasised the challenges facing policymakers. Growth remained tepid, in large measure reflecting very soft household spending,” he observed.
Australia’s GDP grew by 0.2 per cent in the fourth quarter of 2023, according to the national accounts released by the Australian Bureau of Statistics (ABS) and saw its smallest increase in a quarter-century at just 1.5 per cent over the year, excluding the pandemic years.
Miller posited the likely outcome that an easing process will commence around mid-year, with the ECB first cab off the rank in June or July, followed by the Fed in late July, and the RBA in early August.
“Without doubt, the major uncertainty attaching to the sort of timing of central bank policy rate cuts outlined above remains the ‘stickiness’ of inflation. Rather than ‘immaculate’ and smooth, the process of disinflation tends to be more disjointed: a process of ‘two steps forward and one step back’ with the ‘last mile’ to the inflation target proving particularly challenging, particularly in an environment (such as in the US) where economic activity is resilient,” the market strategist explained.
“Even outside the US, where that resilience is largely absent, structural rigidities, particularly those attaching to the labour market, make for ‘last mile’ challenges.”
In Australia, inflation data has surprised a little on the downside, Miller said, with signs that the inflation picture may even be ahead of the RBA’s current forecasts.
Inflation rose 3.4 per cent in the 12 months to January 2024, according to the latest monthly consumer price index (CPI) indicator from ABS, down from 4.3 per cent a month earlier. The increase represented the lowest annual inflation since November 2021 and came in below market forecasts of a 3.6 per cent rise.
“Softer household spending may account for some of [the downside] but with the recent national accounts revealing that unit labour cost growth – the most relevant labour cost gauge for inflation – continuing to run close to 7 per cent in annual terms, it would be wise for the RBA to avoid declaring victory just yet,” he observed.
“There are signs, however, that the inflation picture may improve at least in line with – and maybe ahead of – the current RBA projection. While elevated, unit labour cost growth has been declining on a quarter-by-quarter basis as productivity growth has bounced from the abject rates of growth in the first half of 2023.”
Miller continued: “Were the soft economy to see the unemployment rate rise above the RBA projection of a 4.2 per cent average for the June quarter (which in my view seems likely) and were inflation to track at or below the RBA projection (plausible), perhaps reflecting the governor’s ‘optimistic’ productivity scenario, an August rate cut seems a reasonable central scenario.”
That would demonstrate an “appropriate” balancing of the RBA’s dual mandate, he offered.
Importantly, Miller cautioned against focusing only on the Australian inflation story, with global readings also “critical” in policy decisions.
“Too ‘sticky’ an inflation rate globally as well as domestically may yet upset the emergent positive narrative on policy rate reductions in the second half of the year,” he said.
