Services, housing costs a risk to inflation outlook, Reserve Bank warns
Stronger-than-expected inflation in the labour-intensive services sector and housing construction are prompting the Reserve Bank to question whether it has underestimated the heat in the economy.
Stronger-than-expected price hikes in the labour-intensive services sector and for housing construction risk derailing the Reserve Bank’s inflation forecasts, leading its board to question whether it is underestimating just how hot the Australian economy is running.
Minutes from the RBA’s September 29-30 monetary policy meeting, released on Tuesday, revealed unease among board members after hotter-than-expected monthly inflation figures for July and August. The central bank held the cash rate steady at 3.6 per cent at that meeting.
While the minutes acknowledged the monthly inflation figures could be volatile as they don’t capture the full basket of goods and services included in more comprehensive quarterly inflation data, several components pointed to persistent price pressures.
In particular, board members highlighted stronger-than-expected price growth in so-called “market services”, which include everything from catering to dog grooming, along with rising costs in new home construction.
These trends, the minutes noted, suggested the new September quarterly inflation data, set for release in late October – just days before the RBA’s next cash rate call on November 4 – “might be higher than the staff had expected”.
In staff forecasts published in August, the RBA’s economists projected that their preferred measure of underlying inflation would ease to an annual rate of 2.6 per cent by year’s end, slightly lower than the 2.7 per cent reading recorded in the 12 months to June.
But the minutes warned that if inflation proved to be higher than forecast and the labour market remained tight, the RBA may be misjudging the underlying strength of the Australian economy.
“Members noted that the combination of potentially higher-than-expected inflation and broadly stable labour market conditions, if sustained, could imply that the staff’s assumption regarding the balance between aggregate demand and potential supply was incorrect,” the minutes read.
The board also discussed the experience in other countries where services inflation has remained elevated for longer than expected, which could offer “potential lessons” for Australia’s economic outlook.
Stronger household consumption had also surprised the RBA after a jump in consumer spending was recorded in the June quarter. Along with broader momentum across a wide range of spending categories over the preceding year, this suggested the recent recovery in expenditure was “likely to persist”, the board said.
September’s meeting minutes come amid growing expectations that the shallow easing cycle by the RBA, which has cut interest rates just three times from their peak of 4.35 per cent, is nearing its end.
Money markets ascribe just a 44 per cent chance of a rate reduction at the RBA’s November meeting, and are not tipping the central bank will deliver another cut until March.
Most economists are similarly expecting just one more cut, with the Commonwealth Bank’s head of Australian economics Belinda Allen pointing to a growing risk of no further reductions.
“Evidence is building that the onus will be on the data to prove why further rate cuts are needed for the Australian economy,” she said.
