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The RBA, Fed, labour markets and inflation 

• With many competing influences in the global macro backdrop, in this Weekly we take a step back and outline a framework for how we are making sense of the world.
• The current environment can be thought of as a product of three significant overlapping shocks, which are common globally: COVID, Russia-Ukraine, and the significant monetary policy response to inflation. That inflation is in large part the product of the first two shocks.
• COVID saw services spending switching to goods and housing spending, the resultant sectoral capacity constraints generating goods inflation. Border closures drove some of that switch in spending, but also disrupted labour supply, adding to labour market tightness. The path to normalisation has also created inflationary frictions that shouldn’t be assumed to be fully persistent, as pent-up demand met fixed capacity in certain services sectors. Russia’s invasion of Ukraine reverberated through global energy and other commodity prices.
• Recent developments show that some of these atypical features of the backdrop are shifting: the earlier lift in goods price inflation is reversing, and we expect this to show up in the inflation data in coming months; global energy prices have reversed a significant amount of the rise experienced following Russia’s invasion, even as they remain elevated; but services inflation is being boosted by reopening frictions, most evident in travel costs in the Australian CPI; and labour markets remain tight.
• The global nature of many of these shocks mean there are a range of indicators we can watch. We think price components of US ISM Surveys to be a useful guide to how the common component of the current shock evolves. For the labour market, useful indicators include Challenger Layoffs and JOLTS.  With the US tending to lead this inflation cycle, these can be useful indicators from a domestic perspective as well, and can complement timely indicators including the NAB Survey and SEEK Job Ads.

For policymakers, it remains important that central banks take account of the peculiar COVID forces impacting economies and inflation globally. There is a risk of overtightening if central banks target the lagging indicators of inflation and wages and miss some of the peculiar forces that could drive an inflation unwind.

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