The RBA blinks

Surprise move by the RBA this afternoon, increasing the cash rate by only 25 basis points to 2.60%. Well below the widely expected increase of 50 basis points.

This move is a huge mistake by the RBA. Now is not the time to show weakness and turn dovish. Inflation is still running far to hot. The monthly figures out last week showed no slowdown in core inflation, the labour market is still incredibly tight, and consumer spending has remained well above trend. Inflation expectation out this morning were up 0.6%!

There are no signs of inflation slowing and pulling back on the pace of interest rate rises will only send the wrong signal to the market and households, further stimulating inflation.

Finally the AUD has been under significant pressure the last week and needs further support. A doveish pivot by the RBA will do nothing to help the AUD maintain its value and a lower AUD means more imported inflation.

Household savings will fuel inflation

News of the RBA slowing or stopping rate increases is overdone. The RBA's inflation fight is far from done. During the pandemic period, Australia households stashed away $465 billion in savings, or which $294 billion was excess saving (that is savings above the long term saving rate).

One way to think of savings is as deferred demand. Rather than spending the money now, and creating demand for goods and service now, a household can save that money and spend it later, decreasing demand now, but increasing demand for goods and services at some-point in the future when they decide to spend that money.

Unlike in America, Australian's are yet to start tapping into that savings pool to fuel their spending. In fact, as at 30 June 2022, the savings rate in Australia was still well above the long term average (8.7% vs 6.3%).

This means there is still a lot of deferred demand waiting to be deployed in Australia. More than enough to keep inflation well above trend for several quarters without further intervention by either government of the RBA.

Australian Petrol Prices

With the fuel excise cut ending last week its expected that petrol prices will rise. However, a lot of factors go into the price we pay for petrol at the bowser, including the price of oil and the value of the Australian dollar.

To get an idea of where petrol prices might go in the next few months, I had a look at the ratio of Sydney petrol prices to oil prices converted to AUD over the last twelve months.

The impact of the excise cut comes through clearly in this analysis. Pre-excise cut, the petrol prices averaged 1.53 times the prices of oil, and never fell below 1.46 times. Following the excise cut, the ratio averaged 1.20 times and never rose above 1.32 times.

What does this mean for petrol price in October, now that the fuel excise gone back up?

While future prices largely depend on movement in the AUD and oil prices (and are much more sensitive to oil price movement), if we use the numbers from the today and the ratios we were seeing before the excise cut, we should see petrol prices in Sydney of around $2.10 per litre or around 25 cents per litre higher than they are now.

Cash Rate Predictions

With the RBA Board meeting next Tuesday, the market yields are implying an increase of 50bp (to 2.35%) as ~70% likely.

My guess is we'll get a 50bp increase on Tuesday, especially given the strong core inflation seen in the monthly CPI numbers released yesterday. The recovery of the AUD over the last few days means a larger increase probably isn't warranted at this point.

The market is also anticipating rates to peak at 4.14% mid-next year. This is well above economists expectations and feels a bit high to me as well given current conditions. However, as we've seen over the last week in the UK, conditions can change very quickly so the value of longer term forecasts is pretty limited.

Monthly CPI

The ABS's new monthly CPI indicator is out today, covering June, July, and August 2022.

Headline CPI:
🦉 in June rose 6.8% YoY
🦉 in July rose 7.0% YoY
🦉 in August rose 6.8% YoY

Excluding volatile items CPI:
🦉 in June rose 5.5% YoY
🦉 in July rose 6.1% YoY
🦉 in August rose 6.2% YoY

The main contributor to the easing of headline inflation from July to August was a significant fall in fuel prices. This is reflected in the CPI figures excluding volatile items, where inflation continued to rise.

While these figures aren't a robust as the quarterly figures that the ABS puts out, and it might take some time to get a fix on their accuracy and impact, they do paint a picture of core inflation that is becoming more entrenched.

This should provide more than enough support for the RBA to increase rates another 50bp next week.

Link to the data: https://www.abs.gov.au/media-centre/media-statements/monthly-cpi-indicator-rose-68-year-august

August 2022 Retail Sales

Retail sales figures are out for last month and they best expectations again. Retail spending was up 0.6% on last month against expectations of a 0.4% increase. Year on year spending is up 19.2%. However this isn't the best comparison because August last year was impacted by lockdowns. A better comparison is to spending in February 2020, before COVID really began to impact the economy and spending since then is up a remarkable 25.2%.

Every category of spending remains well ahead of trend, which really highlights just how robust household consumption has been. In August growth was driven mainly by department stores (up 2.8%), household goods (up 2.6%), and the cafe and restaurant sector (up 1.3%).

The clothing and soft goods (down 2.3%) and other retail (down 2.5%) sectors saw fairly significant declines. However, it's worth noting that these sectors have also seen the most growth since February 2020.

Despite poor consumer sentiment and 2.25% of interest rate increases, households continue to spend and the longer household spending remains elevated, the bigger the risk that inflation remains high. It seems the key driver of continued strong spending is the robust employment market. As long as households feel they have secure employment, they are continuing to spend.

This is going to be a key conundrum going into next week's meeting for the RBA.

It will also be interesting to see how these figures look in-light of the ABS's first release of monthly CPI figures, due out tomorrow.

We should keep the stage three tax cuts

A well argued piece in the AFR on why repealing the stage three tax cuts would be a terrible idea.

A few key points:

"... 94 per cent of Australian taxpayers will be paying no more than 30¢ in the dollar at this bracket. Those who characterise stage three as a tax cut for the mega-rich deliberately ignore this fact."

Flat rate income taxes are wonderful because they provide consistent incentives to earn more income. We want people earning more income and disincentivising them with higher marginal tax rates for doing so has always been stupid.

and...

"The 45 per cent tax bracket has a current threshold of $180,000, which has remained unchanged since 2008. It has not been indexed with inflation for 14 years."

If tax brackets were indexed to inflation like they should be the top tax bracket would already be at $234,000. Increasing it to $200,000 is will still mean higher income earners are paying more in real terms than they were in 2008.

and finally...

"The best and brightest are not stupid. They won’t bring their skills to Australia if they are to be clobbered with some of the highest taxes in the developed world."

While our top marginal rate is comparable with many countries, it cuts in much earlier than many comparable economies, making us an uncompetitive location for skilled migrants (especially when you factor in some to the world most expensive housing as well).

Why stage three tax cuts should be here to stay

August Labour Force Statistics

Labour force statistics are out for August 2022, and it’s all good news.

⭐️ Unemployment was 3.5% (⬆️0.1%)
⭐️ Participation was 66.6% (⬆️ 0.2%)
⭐️ Underemployment was 5.9% (⬇️ 0.1%)
⭐️ Employment to Population ratio was 64.3% (⬆️0.1%)

Don’t get distracted by the headline unemployment figure. It’s easy to see employment going up and think things are worse but you’d be wrong. The unemployment rate is up due to more people looking for work. There were actually 33,500 more people in work August than July 2022.

Underemployment also dropped to 5.9% which meas labour underutilisation was steady at a 40 year low of 9.4%.

These figures reflect an employment market that remains very strong. I don’t think we’ll see any change in the RBA’s strategy off the back of these numbers.

US August CPI

US CPI figures for the month of August were out overnight and they were higher than expected.

🔥 Core CPI MoM: ⬆️ 0.6% (Est. 0.3%, Prev. 0.3%)

🔥 Core CPI YoY: ⬆️6.3% (Est. 6.1%, Prev. 5.9%)

🔥 Headline CPI MoM: ⬆️0.1% (Est. -0.1%, Prev. 0.0%)

🔥 Headline CPI YoY: ⬆️8.3% (Est. 8.1%, Prev. 8.5%)

Shelter, food and medical care were the main drivers for the increase, more than offsetting a 10%+ decline in gas prices.

In response the market is now pricing ain a 75bp rate rise at a 76% chance and a 100bp rise at 24%. The chance of a 25pb rise has gone to zero.


What’s this mean for Australia? Almost certainly higher interest rates here. If the Fed raise rates by 75bp or 100bp next week (as they almost certainly will) there is very little chance that the RBA will be able to increase rates here by only 25bp. Expect another 50bp increase in October.

The UK’s Energy Plan is Maddness

Britain's new energy plan is nuts.

For those who haven't heard, the British government plans to cap the price of energy for household for the next two years.

This will expose the British Government to essentially unlimited liability. The total cost of the program is estimated at over £140 billion. This is equivalent to almost 5% of Great Britain's GPD, and the whole amount will be borrowed.

They'd be far better off spending the money addressing the long term problem and transitioning to alternative energy sources.

The price cap will also make the energy crisis worse. High prices provide important signals to consumers to curb spending and seek alternatives. Prolonged high prices also provide important signals to capital markets that it's viable to invest in developing alternatives.

By putting in place this price cap, the British Government is wasting public money to make the energy crisis worse. A little like our government did, on a much smaller scale, but reducing the excise on petrol.