The past week has delivered disappointing economic news with lower than expected consumer spending (monthly retail sales) and higher than expected inflation (monthly CPI).
This mix places the Reserve Bank of Australia (RBA) in a difficult spot with an extended period of on hold policy looking increasingly likely.
Last week’s inflation print for April at 3.6% year on year was higher than the previous month’s 3.5% and higher than consensus expectation of a 3.4% rise.
Inflation Stickiness Fuels RBA Concerns
While the monthly CPI series is volatile, the figures reinforce the persistence of Australia’s inflation problem with headline inflation “stuck” around 3.5% since December, and the underlying inflation rate trending at around 4%.
Indeed, at face value 'underlying' inflation appears to be at least modestly re-accelerating. The trimmed mean estimate for April ticked up again to 4.1%, the fastest since November 2023, after 4.0% in March and up notably from the recent trough of 3.8% in January 2024. This would be worrying for the RBA.
In terms of the two broadest categories, goods price inflation held at 3.3% year on year, while services inflation ticked back up to 4.0%. The rise in goods prices – mainly clothing and footwear – may well be a blip but will not go unnoticed by the RBA.
The narrative has been that goods prices (about a third of CPI) should ease to 1-2%, allowing services (the other two-thirds of CPI) to track at 3-4%. This would allow overall CPI to still get near the 2-3% inflation target. So, the recent plateauing of goods inflation at over 3% is troubling and in stark contrast to much more benign trends playing out in the US for example. However, we believe it is too early to conclude that goods price inflation will remain stuck at this level, particularly with consumer demand weakening.
In terms of the sub sector categories, the biggest increase in April was in health insurance premiums, while bad weather caused fruit and vegetable prices to rise. There was modest rent relief with the year on year pace easing but rent inflation remains high at 7.5%. While the inflation pulse was quite broad, electricity and gas prices did fall slightly and will fall significantly in Q3 as subsidies hit.
The monthly CPI remains a somewhat experimental series. But to the extent it is the most comprehensive and timely measure of inflation available, it will be closely watched over the next month in the lead up to the full quarterly inflation series due at the end of July. Only 60% of items are collected every month, while 30% are collected once a quarter (with roughly 10% in each of the three months), and 10% are collected annually. It is somewhat troubling that the quarterly figures due in late July place more weight on services, which are proving more stubborn than goods prices which are “over-indexed” in the monthly series. Indeed, the trend of recent quarters has been encouraging monthly inflation news early in the quarter, followed by more sombre inflation reads at the end of the quarter, as more services prices enter the sample.
On the positive side, lower petrol prices in May should see the monthly CPI ease back again, all things being equal, while health insurance inflation should also ease.
Beyond the next few months, an additional consideration is the impact of upcoming government subsidies which will impact headline inflation from the third quarter. Electricity subsidies should deduct 0.5% from CPI in Q3 and the RBA will likely reduce its end-of-year “headline” (2024) inflation forecast from 3.8% to 3.3%. Of course the counter argument is that these subsidies alongside the modified stage 3 tax cuts will add some second round inflationary pressure as they add to aggregate demand. Moreover, inflation will mechanically rise in FY26 unless the rebates are extended.
What Does All This Mean For The RBA?
Upside inflation surprises clearly have the RBA on notice and in absolutely no inclination to ease policy anytime soon. The federal government's attempts to ease headline inflation, via some cost of living subsidies, are unlikely to influence the RBA which will focus on underlying measures of inflation. However, the RBA will be attuned to the weakening in the economy in thinking about policy.
From this perspective as we highlighted in our introduction, this past week also delivered some relatively sombre news on the Australian consumer which would also be feeding into the RBAs reaction function.
Spending is Stalling
Nominal retail sales (figure 3) rose only 0.1% in April, which was below the consensus estimate (+0.2%) and followed a very weak -0.4% in March. Overall, the month on month trend is averaging flat in recent months.
The year on year pace of retail sales has been trending at a very subdued 1-2% since mid-2023 implying negative “real” retail sales growth. While retail sales are closely watched, the survey only covers around one third of total consumption.
The recently released March end data for household spending eased to 2.2% year on year, the slowest since December 2023. While slightly less timely, this indicator covers a much larger (two thirds) share of total consumption.
Overall, consumption data remains broadly consistent with our forecast of real consumption growth in Q1 2024 to show no growth quarter on quarter. The consumer has clearly slowed sharply, although spending is not collapsing - it is being supported by very strong population growth and healthy spending from the older cohort of cash up, lowly geared consumers, supporting areas like travel.
Early Warning Signs in a Robust Labour Market
May also delivered somewhat mixed news on another key piece of the RBA’s economic puzzle – the labour market. Employment in April rebounded a strong 38k month on month, above the consensus estimate (+24k). However, this came after March surprisingly fell -6k. The average in recent months remains ~30-50k, which is still strong. This implies momentum in employment is still relatively resilient; albeit lead indicators (job ads etc) imply a significant slowing ahead.
Indeed, hours worked were flat month on month and the year on year pace dropped to -0.8%, the worst since COVID. Historically, the labour market first adjusts via weaker hours rather than jobs, and this broad trend appears to be repeating.
The unemployment rate is typically not as volatile as the monthly employment numbers, but has also bounced around for several months, making it difficult to form a strong view. Unemployment spiked again to 4.1% in April (figure 6). The unemployment rate has already spiked, but then subsequently fell back sharply, and the Australian Bureau of Statistics (ABS) noted the increase in unemployment reflected more people than usual indicating they were waiting to start a job. The unemployment rate is now up significantly from the trough of 3.5% in ~mid-2023, though we expect it to have edged lower again in May based on the comments from the ABS.
Unemployment would need to continue to rise in coming months to really worry the RBA. Indeed, the level of unemployment remains below 'NAIRU/full employment', estimated by the RBA at ~4.5%. Meanwhile, the participation rate ticked up to 66.7% to near a record high level. Overall, this implies the labour market is easing, but for now remains relatively tight compared with long-run trends.
We expect unemployment to edge higher over the balance of the year which should help ease inflationary pressures marginally. We note that wages growth data looks to have peaked at ~4%, albeit this week’s Fair Work minimum wage and award decisions will be closely watched following last year’s significant increases. We expect a more subdued ~4% outcome this time around.
Worrying Trends Suggest RBA to Extend Pause
In summary, weak retail sales and broader weakness in consumption cautions against additional RBA rate hikes despite sticky inflation. At a minimum, a higher for longer scenario for the RBA cash rate at least into 2025 appears likely.
The ongoing weakness in consumption is consistent with monetary policy in 'restrictive' territory, causing consumer demand to weaken and unemployment to lift with a lag. In our view this reduces the urgency to hike rates.
We still expect the first rate cut will be February 2025. As previously discussed, the RBA will lag easing by other global central banks which, should all things equal, support the Australian dollar but will present near term headwinds at the margin for our equity market.
Medium term, we still see a relatively modest and gradual 3-4 cut easing cycle to a 3.35-3.6% cash rate by the end of 2025. This should also help long term bond yields drift lower. Interest rate markets have now pushed back the timing for the first RBA rate cut until
Q4 2025.
We see this as too hawkish given the weakening in consumption and lead indicators suggesting a weaker labour market. However, the federal government's somewhat significant fiscal injection does raise the risk that our forecast for Q1 2025 cut proves premature.
Written by
David Cassidy, Head of Investment Strategy
David is one of Australia’s leading investment strategists.
About Wilsons Advisory: Wilsons Advisory 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 Advisory 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 Advisory 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 Advisory”). 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 Advisory contains a financial product advice, it is general advice only and has been prepared by Wilsons Advisory 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 Advisory's 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 Advisory 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 Advisory 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 Advisory disclosures at www.wilsonsadvisory.com.au/disclosures.