The RBA's Deputy Has Named the Only Good Reason for a Fifth Rate Rise. It Has Nothing to Do With Oil

A week after the September jobs report showed unemployment at a five-year high, the Reserve Bank of Australia's deputy governor has set out why the bank may raise rates anyway. "We're a week and a half from the policy meeting, and we're still finalising our forecast. I don't know for sure, but a few things are clear, and the inflation outlook looks materially worse than we projected in the August report," Andrew Hauser said at Citi's Australia and New Zealand Investment Conference on Wednesday. The same three upside risks remain, he said: oil prices now about a third higher than the August projection assumed, AI and technology prices feeding through to the CPI, and a data centre construction boom on top of a run of global demand shocks.

The sentence that moved markets was about expectations. Business surveys and the bank's own liaison show an increasing share of firms believing that inflation around 3 to 3.5 per cent is the new normal. "That is the central banker's nightmare. We can't allow expectations to shift away from the target," Hauser said, adding that some in the community are "not sure if we're going to bring inflation back into target at all". Headline inflation was 4 per cent in the August monthly indicator against the bank's forecast of 3.9, and he said underlying inflation for the September quarter, published on 28 October, is likely to come in above the August forecast too. Pricing for a 3 November rise went from about 27 per cent before he spoke to between 41 and 57 per cent after, depending on the measure.

The bank publishes its new forecasts with the decision on 3 November.

From the analysis

Hauser did not pretend the choice is easy. "Do you do more to tackle higher inflation, recognising that that means weaker activity, weaker labour market? Or do we hold our horses to protect the labour market, but accept the risks in so doing that this upside inflation risk embeds, and that becomes more expensive to deal with. Those are hard choices." He accepted that policy is working, that housing and the labour market are slowing, and that monetary policy cannot deal with an oil shock directly. "Even though we are laying shorter-term pain on top of pain, it's to prevent a longer and potentially far worse pain down the track if inflation expectations get locked in," he said.

Sox argued last week that the labour market had done the bank's arguing for it and that a fifth rise would be tightening into a slowdown the August forecasts never anticipated. Hauser's reply, in effect, is that the slowdown is the point and that the forecasts were wrong in the other direction. On the data he is right about the forecasts. Unemployment at 4.7 per cent is above the bank's 4.5 per cent year-end projection and inflation is above its 3.9 per cent projection at the same time, which is the combination that gives a central bank no comfortable option.

We think Hauser has named the only argument that justifies a fifth rise, and it is the one about expectations. A rate rise does nothing to the price of diesel landed in Australia, as he conceded. What it can do is tell every business currently repricing on the assumption that 3.5 per cent is permanent that the bank disagrees, and that the cost of testing it will be weaker demand. That is a credibility purchase, and it is expensive precisely because four rises have not yet bought it. If the trimmed mean for the September quarter comes in at or above the path the bank's August forecast implied, the board should move and say why. If it comes in below, the expectations problem is one for the bank's communication, and a fifth rise with unemployment climbing would be paying twice for the same lesson.

The bank publishes its new forecasts with the decision on 3 November. Before then the Australian Bureau of Statistics releases the September quarter CPI on 28 October, the same day the Bank of Canada decides with its core measures below target and the Federal Reserve decides with its core measures above. Hauser's own test is whether the bank has "done enough". The number that answers it arrives on Wednesday week.

The Semaform

The news

The Reserve Bank of Australia's deputy governor Andrew Hauser said on 21 October that the inflation outlook is materially worse than forecast in August and that inflation expectations risk becoming entrenched, lifting market odds of a fifth rate rise on 3 November to better than even.

Sox’s view

The expectations argument is the only one that justifies a fifth rise, since rates cannot touch the oil price. The 28 October trimmed mean should decide it: at or above the August forecast path, raise and explain; below it, hold and fix the communication.

Room for disagreement

Hauser and the hawks say that letting 3.5 per cent become the assumed norm would be far more costly to reverse later; JP Morgan and CBA expect the bank to hold, arguing four rises are still working through and the labour market is already weakening faster than forecast.

Sources

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The RBA's Deputy Has Named the Only Good Reason for a Fifth Rate Rise. It Has Nothing to Do With Oil

The Semaform

Sources

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