Introduction to Australia’s Economic Outlook
The recent release of Australia’s monthly inflation data for August has led to a significant shift in the outlook for interest rates among various banks. The data revealed that annual headline inflation rose to 3.0%, up from 2.8% in July, reaching the top end of the Reserve Bank of Australia’s (RBA) target band for the first time since July last year.
Understanding the Inflation Data
Excluding volatile items and the holiday travel metric, inflation hit 3.4% on an annual basis, its highest reading since July last year. The trimmed mean figure performed better, registering at 2.6% year on year; however, this is due to the exclusion of the significant rise in electricity prices, as the positive effects of various subsidies are no longer reflected in the data.
Impact on Interest Rates
As the various bank economists analyzed the data, they quickly revised their outlook for rate cuts. Prior to the inflation print, NAB had two rate cuts penciled in for November and February. It now sees the RBA on hold until May next year. Deutsche Bank warned that the “trimmed mean is stickier than we expected”, noting that further rate cuts were delayed until next year. Meanwhile, the Commonwealth Bank warned that a November rate cut was no longer a “done deal” following the CPI data.
The Big Question: Inflation vs. Unemployment
It’s certainly true that inflation is stickier than some anticipated, but the big question is whether or not it will be the sole defining metric of the current rate cut cycle. Currently, the RBA has a peak in unemployment of 4.3% penciled in all the way out to mid-2027. Yet a rise in unemployment of less than 0.1 of a percentage point would see that figure exceeded, if only slightly. With the economy not producing enough jobs to keep up with the growth in the size of the labor force, assuming a stable participation rate, unemployment appears set to rise unless job growth can refire in the coming months.
The RBA’s Dilemma
This would leave the RBA in a challenging position; in a matter of potentially just a few quarters, unemployment could be rising to a level significantly higher than its long-term forecasts and inflation could still be simmering at a deeply uncomfortable level. At that point, what do Michele Bullock and the RBA do? Do they let inflation run hotter than the RBA would like in order to cut rates in an attempt to protect the labor market? Or do they keep rates roughly where they are to contain inflation and leave the issues of a deteriorating labor market to fiscal policymakers?
Conclusion
One suspects that if the labor market deteriorates badly enough, the RBA will be left with little choice but to cut rates, regardless of issues with simmering inflation. But the big question is where would that line be drawn? How high would the nation’s jobless rate have to rise before the pressure, both internally and externally, was enough to force their hand? In a scenario in which the labor market fails to produce enough jobs to keep up with working-age population growth, this question could come to define the short- to medium-term future of the Australian economy. Ultimately, the RBA’s decision will have a significant impact on the economy, and it is crucial to monitor the situation closely to understand the potential consequences of their actions.
