With Australia's inflation outlook taking on increased uncertainty and upside risks, optionality is the name of the game for the RBA. An important speech from Bank Governor Philip Lowe during the week discussed the global and domestic inflation trends and led to the conclusion that the inflation trajectory would depend on the rebalancing of spending patterns and the recovery in the labour market. The central scenario for the RBA is that the current inflation pressures are temporary and will ease as spending patterns rotate back towards pre-pandemic shares of durable goods and services, and the labour market adjusts to the increase in demand for the latter as reopenings broaden out. But it is acknowledged by the RBA that the situation could turn out differently and inflation pressures may be more persistent. Markets are therefore keeping rate hikes priced into next year's profile despite further direct push back on that scenario from Governor Lowe this week. October's meeting minutes cited the "shifting upwards" in the distribution of possible inflation outcomes and the potential for rate hikes to come earlier than its 2024 guidance as reasons for the Board formally ending its 3-year yield target policy. Of course, that came after the RBA decided not to defend the 0.1% target against a severe market repricing in the days leading up to the meeting. The ungainly exit from the policy that ensued clearly sits with some unease as the minutes revealed a review of the yield target is set to take place next year.
Governor Lowe's contribution to the transitory inflation debate this week centred on wages growth. The Governor puts forward that prices and wages are likely to move together over time. As such, the RBA will be looking to wages growth as a "guidepost" in assessing the stickiness of inflation. Governor Lowe's estimation is that sustainably delivering on the 2-3% inflation mandate is consistent with wages growth at "3 point something", based on inflation hitting the midpoint of the target and productivity gains of around 1%. This week's update of the Wage Price Index for Q3 showed there is a long way to go in achieving this. Growth in the headline WPI was in line with market and RBA estimates at 0.6% in the quarter and 2.2% over the year (reviewed here). Despite forecasts for the labour market to tighten considerably, the RBA expects wages growth to rise only gradually, due in large part to the inertia embedded into wage-setting processes in Australia. Annual reviews of increases to the minimum wage, years-long enterprise agreements and caps to limit growth in public sector wages are likely mean slow progress in wages recalibrating to a tightening labour market. Skills shortages looked to be generating upward pressure on wages growth in only a couple of industries in Q3, mainly in construction and professional services.
Moving offshore to the US where prospects for a speedier recovery in the labour market amid the high rate of inflation are opening up talk of an acceleration in the Federal Reserve's tapering process. Current guidance is that Fed asset purchases will slow by $15bn per month to be completed by mid-2022. However, the Vice Chair Richard Clarida and Governor Christoper Waller said on Friday that a more accelerated withdrawal of QE might be appropriate if the economy achieves faster progress towards the Fed's objectives. This aligns with comments made by the St. Louis Fed President James Bullard earlier in the week, though a couple of other Fed officials had been of the view that the current taper schedule need not be sped up. This all comes with markets still awaiting a call from President Biden on his nomination to chair the Federal Reserve, the decision understood to be between the incumbent Jerome Powell and Fed Board member Lael Brainard. US data through the week was generally upbeat, indicating that momentum in the economy was building up after Q3's slowdown. Industrial production strongly outperformed expectations with a 1.6% rise posted in October, for its best increase in 8 months restoring production to pre-pandemic levels. But it was a strong report on retail sales that was the highlight of the week. October sales beat consensus rising by 1.7% (vs 1.4%) while the control group — a proxy for household consumption in GDP accounting — advanced by 1.6% (vs 0.9%) to be up sharply from a modest gain in September (0.5%). While there is an inflation component to these gains, that is well understood so the comfortable beat on expectations is significant. These outcomes saw both headline and control group sales accelerating further above pre-Covid levels.
In Europe, rising Covid cases have put lockdowns and restrictions back on the table with winter approaching. On inflation, with euro area headline (4.1%yr) and core (2.0%yr) rates surging to highs dating back to 2008, a speech by ECB Executive Board member Isabel Schnabel set out the importance of taking a risk-management approach to monetary policy. The ECB's forward guidance is sending a strong signal that rates will not be lifted in response to inflation pressures seen as temporary, but it was appropriate to retain some optionality in the event that longer-term inflation expectations were to deviate from the target. In the UK, inflation for October came in hotter than expected as annual headline CPI lifted from 3.1% to 4.2% and the core rate elevated from 2.9% to 3.4% — both measures now at decade highs. The main contributor to the rise this month came from household energy prices following the increase to the price cap announced by the regulator. With the next reset due in April and given the surge in wholesale energy prices, inflation is expected to be pressing 5% by Q2 next year. Inflation pressures drove the Bank of England close to raising rates at its previous meeting, though it held back to await more data on the labour market as it transitioned off the furlough scheme. That data started coming to hand this week and with an upside surprise on employment pushing the unemployment rate down from 4.5% to 4.3%, a 15 basis point rate hike is priced in for the December meeting.
