June 1, 2021
AMW: Inflation expectations lifting globally but not in Australia yet
We look at inflation expectations which have rising strongly in the US and the potential implications for the US Fed.
- We note recent remarks by the Fed’s Quarles who stated the Fed’s patience on inflation is bounded by inflation expectations: “we need to remain patient in the face of what seem to be transitory shocks to prices and wages so long as inflation expectations continue to fluctuate around levels that are consistent with our long-run inflation goal”. Markets therefore are likely to become more sensitive to inflation expectations going forward.
- To analyse inflation expectations, we re-create the Fed’s Index of Common Inflation Expectations, which summarises 21 indicators of inflation expectations. We find inflation expectations in the US are now back to their highest levels since 2014, though do have room to go higher before the Fed becomes more concerned on whether inflation expectations risk entrenching higher transitory inflation. The University of Michigan 5-10yr inflation expectations will be particularly closely watched given it was previously mentioned by former Fed Chair Yellen.
- Australian inflation expectations in contrast to the US remain well below recent averages. Here we adapt the Fed’s Index of Common Inflation Expectations to the Australian context and find inflation expectations in Australia are still around pandemic lows and are below the levels that expectations averaged when inflation was within the RBA’s 2-3% target band. Likely part of the reason for subdued expectations was the RBA’s unwillingness to ease policy further prior to the pandemic when inflation was persistently below target. Subdued inflation expectations are seen in various measures, including those by consumers, economists and union officials
- Whether measured inflation expectations mean much in an Australian context is up for debate (in contrast to the US). RBA Deputy Governor Debelle has consistently downplayed the signals sent by market inflation expectations, noting expectations were anchored in 2018 even after a prolonged period of inflation being below the mid-point of the 2‑3% target. Regardless of the RBA’s view on market-based measures, inflation expectations outside of market measures remains at very low levels, emphasising the RBA is likely to lag the Fed in the normalisation cycle.
The week ahead
Australia: The RBA meets on Tuesday, but is not expected to reveal much given it has already flagged July as the key meeting where it will consider its unconventional policy settings. Instead, RBA speaking events will be closely watched for guidance with Deputy Governor Debelle before the Senate Economics Legislation Committee on Wednesday. GDP on Wednesday is the main event of the week with pre-GDP partials on Tuesday. For GDP NAB expects growth of 0.7%q/q (consensus 1.1% q/q), reflecting the fact that the economy is transitioning beyond the rebound phase in activity.
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