The September quarter’s above consensus reading for both headline and underlying inflation materially increases the risk of a November rate hike next week, in our view.
Importantly, the quarterly and monthly consumer price index (CPI) trend shows a reacceleration in inflation momentum. So, while year-on-year (YoY) inflation trends are decelerating (albeit slowly), the quarter-on-quarter (QoQ) reacceleration reinforces the conclusion that inflationary pressures are not moderating as fast as the Reserve Bank of Australia (RBA) would like.
RBA governor Michele Bullock said last week that the RBA would not hesitate to raise the cash rate above 4.1% if there were a “material upward revision to the outlook for inflation”, reiterating the RBA’s “low tolerance” for a prolonged period of high inflation.
While there remains some ambiguity around the definition of a “material” upward revision to inflation, there is, in our view, enough to worry the RBA in this CPI report to prompt the RBA to hike rates on November 7.
Market pricing has moved up to just over a 60% probability (as at 26 October) for a November hike. This compares to a 35% probability just before the CPI release. The cumulative probability moves to effectively 100% by December, although a November hike is more likely in our view.
We view the bar for a second, follow-up hike beyond November as relatively high (the market has a 40% probability of another hike in Q1 2024). The futures market is not expecting any policy easing for all of calendar year 2024 (see figure 9). With inflation proving stickier than expected, and the economy slowing quite gradually, this higher-for-longer domestic rate profile appears a reasonable expectation at this point.
Australia’s headline CPI for Q3-23 rose by 1.2% QoQ, which was marginally above consensus (1.1%). Importantly, this was also a sharp re-acceleration from the 0.8% pace in Q2-23.
The YoY rate of 5.4% was also marginally above consensus (5.3%), and also notably above the RBA's implied forecast of ~5.25% from their Aug-23 monetary policy statement.
A key upward driver in the Q3 headline inflation rate was automotive fuel, which jumped by 7.2% QoQ. Looking ahead, automotive fuel prices in Q4-23 are tracking to be up by another ~4%.
On the positive side, Q3 inflation is well down from the December 2022 peak of 7.8% and down from 6.0% YoY in Q2-23 but the re-acceleration in quarterly momentum is worrying. This will concern the RBA enough to hike again next week, in our view.
Treasurer blames global forces but plenty of “domestic” inflation is evident
Importantly, even though fuel was a major driver of headline CPI, the RBA's preferred 'underlying' inflation measure, the Trimmed Mean CPI, still lifted by 1.2% QoQ in Q3, which was higher than the consensus estimate of 1.0%. At 5.2%, the YoY trimmed mean was above consensus (5.0%), and well above the RBA's implied forecast (using the Aug-23 statement on monetary policy) of 4.8% to 4.9%.
Less global disinflation evident while domestic inflation trends look sticky
Outside of petrol, there is some evidence of the moderation in global inflation flowing into Australia, such as easing goods prices. However, even goods prices are not decelerating as fast as the US, for example. At the same time, domestic inflation trends remain disconcertingly sticky.
Lagging the global downswing
Tradable CPI (mostly goods) moderated to 0.7% QoQ (after 1.1%), and the YoY eased further to 3.7% (after 4.4%). However, non-tradables (mostly services) remain stickier at 1.3% QoQ (after 0.8%), and 6.2% YoY (after 6.9%). Overall, goods inflation rose 1.2% QoQ (after 0.9%) and 4.9% YoY (after 5.8%). By way of contrast, core goods inflation in the US has dropped to zero in YoY terms.
Services having a slow slowdown
Australian services inflation stayed elevated at 1.0% QoQ (after 0.8%), and 5.8% YoY (after 6.3%). Elevated readings are evident for a range of services such as veterinary services, restaurant meals and hairdressers. Annual inflation continues to rise for some service categories including rents, dental services and insurance. While inflation for holiday travel fell QoQ, it is still up 6.8% YoY.
Given the weak AU$, combined with high oil prices and sticky services inflation, there would appear to be 'material' upside to the RBA’s forecast for Q4. For headline inflation, the RBA forecasts 4.1% YoY. For the trimmed mean, the current RBA forecast is only 3.9% YoY.
While inflation in Australia in YoY terms is continuing to moderate, it remains higher than expected. It is well above the RBA’s target band (2-3%), and remains well above the current rate in most other major economies.
Indeed, headline CPI in Australia has now been at or above the RBA's target band of 2%-3% YoY for 10 consecutive quarters. Q3 also indicates a breadth of underlying inflation pressure, with more than 70% of the basket still registering YoY inflation above 3% (see figure 3) (the top of the RBA’s target band). The comparable figure for the US is around 50%.
The good news is that Australian inflation has peaked and is trending lower. The bad news is that the easing in inflation pressure is happening more slowly than the RBA expected.
The RBA will remain concerned at the stickiness in a number of key CPI categories (particularly services) and by the slow progress back towards their CPI target band. As a result, a November hike appears likely.
The RBA will release its new inflation and economic growth forecasts in November, after the November rate meeting. September quarter wage growth data will also be released in November. This is unlikely to prompt a follow-on rate hike in December but it will be closely watched.
Overall, the Australian economy is experiencing a declining growth rate, buoyed by very high immigration rates, alongside easing but relatively sticky inflation with a still tight labour market. This suggests an extended period of “on-hold” rates beyond November. The economy will still likely avoid a recession in 2024 but the RBA’s projection of 1.75% real gross domestic product (GDP) growth for 2024 may prove optimistic, in our view.
The domestic equity market has stalled this year. Our view is that it can eke out some moderate gains over the coming year, based on supportive global inflation and interest rate trends, although the domestic earnings cycle is likely to continue to run into headwinds as the local economy slows.
David is one of Australia’s leading investment strategists.
About Wilsons: Wilsons is a financial advisory firm focused on delivering strategic and investment advice for people with ambition – whether they be a private investor, corporate, fund manager or global institution. Its client-first, whole of firm approach allows Wilsons to partner with clients for the long-term and provide the wide range of financial and advisory services they may require throughout their financial future. Wilsons is staff-owned and has offices across Australia.
Disclaimer: This communication has been prepared by Wilsons Advisory and Stockbroking Limited (ACN 010 529 665; AFSL 238375) and/or Wilsons Corporate Finance Limited (ACN 057 547 323; AFSL 238383) (collectively “Wilsons”). It is being supplied to you solely for your information and no action should be taken on the basis of or in reliance on this communication. To the extent that any information prepared by Wilsons contains a financial product advice, it is general advice only and has been prepared by Wilsons without reference to your objectives, financial situation or needs. You should consider the appropriateness of the advice in light of your own objectives, financial situation and needs before following or relying on the advice. You should also obtain a copy of, and consider, any relevant disclosure document before making any decision to acquire or dispose of a financial product. Wilsons’ Financial Services Guide is available at wilsonsadvisory.com.au/disclosures.
All investments carry risk. Different investment strategies can carry different levels of risk, depending on the assets that make up that strategy. The value of investments and the level of returns will vary. Future returns may differ from past returns and past performance is not a reliable guide to future performance. On that basis, any advice should not be relied on to make any investment decisions without first consulting with your financial adviser. If you do not currently have an adviser, please contact us and we would be happy to connect you with a Wilsons representative.
To the extent that any specific documents or products are referred to, please also ensure that you obtain the relevant disclosure documents such as Product Disclosure Statement(s), Prospectus(es) and Investment Program(s) before considering any related investments.
Wilsons and their associates may have received and may continue to receive fees from any company or companies referred to in this communication (the “Companies”) in relation to corporate advisory, underwriting or other professional investment services. Please see relevant Wilsons’ disclosures at www.wilsonsadvisory.com.au/disclosures.