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Analysis:  RBA’s inflation tolerance, is it different to the US Fed, BoE or RBNZ?

• NAB recently re-affirmed its RBA view of being on hold until early 2024 in contrast to market pricing which sees rates lift-off by August 2022. The basis for this view is that while we expect economic activity to rebound strongly as restrictions ease, we see price pressures building more gradually. (see: NAB: Monetary Policy Call – NAB sticks to 2024 for the first RBA cash rate hike).
• Market pricing in sharp contrast is pricing rates lift-off by August 2022. The lift in market pricing is broadly in sync with that of the US Fed, with pricing moving sharply since the BoE flagged the possibility of rate hikes as early as this year. Markets in other words are partly pricing co-ordinated policy moves based on global inflation concerns.
• In this Weekly we expand on why we think: (1) the lift in global inflation is mostly transitory; and (2) why the RBA will lag the US, UK and NZ in rates normalisation with a 2022 rate hike for Australia less likely than what markets are pricing.
• (1) The lift in global inflation is mostly transitory: While everyone is flying blind on how long supply chain disruptions will last, two key factors driving disruptions should fade:
  • (a) consumers will start their pivot away from elevated goods consumption to services as we learn to live with COVID. Non-food goods consumption in Australia is running 9.2% above pre-pandemic and globally advanced economy import volumes are 5% above pre-pandemic. Picking the turning point is less certain, but tentative signs may be emerging from the US and UK; and
  • (b) more countries are starting to transition to living with COVID which will mean less likelihood of crippling lockdowns shutting down key manufacturing areas and major ports in 2022. China here will be important, and it is uncertain when China will end its zero-COVID strategy. Meanwhile port backlogs are unlikely to be back to normal for 6-12 months according to shipping analysts.
• (2) The RBA is likely to lag the US, UK and NZ in rates normalisation coming out of the pandemic. Even though we assess in this Weekly the RBA’s inflation tolerance is not that different to the US Fed, BoE or the RBNZ, there are good reasons to think the RBA will lag other central banks. The RBA Minutes last week noted:
  • (a) the differing inflation starting points with wage/inflation dynamics much higher in the US, UK and NZ prior to the pandemic compared to Australia. One factor behind this was the RBA’s reluctance to ease policy due to financial stability concerns pre-pandemic which entrenched low inflation expectations.
  • (b) the supply side of Australia’s economy has rebounded more sharply than the US and UK. Employment in the US and UK is still below pre-pandemic levels, while in Australia it quickly rose to above pre-pandemic just prior to the recent lockdowns. While pockets of labour shortages do exist, wages growth has not picked up and the government is hinting of a sharp resumption of migration.

Chart 1: Australian core inflation was much lower than other countries prior to the pandemic

Chart 2: Australian wage outcomes were also well below average prior to the pandemic in contrast to other countries which highlights that it may take longer for Australian wage/inflation expectations to become more consistent with the inflation target than in other countries

Chart 3: Global inflation being driven by goods, not services, which suggests a pivot of consumers from goods to services should alleviate inflation pressures

Chart 4: Consumers are expected to pivot from goods to services as countries start to transition to living with COVID – Australian goods spending is running 9.2% above pre-pandemic levels

Chart 5: Consumers are expected to pivot from goods to services as countries start to transition to living with COVID – some signs this may be starting to play out offshore

Chart 6: Central banks will be focused on inflation expectations, can look through transitory inflation so long as inflation expectations do not de-anchor higher. So far in the US they are mostly at average, but the risk is they move higher and markets will likely continue to price central banks hiking earlier than their official forward guidance

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