Reserve Bank of Australia: Stubborn services inflation holding board from easing rates

Stubborn services inflation continues to be an impediment to interest rate relief, according to minutes from the most recent Reserve Bank of Australia Board meeting, but the Board is gaining confidence that inflation is coming under control.

The minutes described services inflation as an issue across the world, noting it was “persistent in several economies” and holding back rate decisions elsewhere.

The RBA board noted that while the risk of inflation returning to target more slowly than expected had eased, concerns over weakening economic activity had intensified.

Sluggish GDP growth through the September quarter and weaker-than-expected consumption raised questions about the economy’s momentum.

Despite a recent uptick in consumer spending, the board remained uncertain about its durability.

Members also flagged the risk of a sharper rise in unemployment, given the ongoing weakness in private demand and slow job creation in the market sector, and noted the risk to unemployment if the public sector jobs growth were slowed abruptly.

“Members judged that the risk that inflation returns to target more slowly than forecast had diminished since the previous meeting and that the downside risks to activity had strengthened,” the minutes said.

The RBA also noted that wage growth was subdued, suggesting “potential labour supply was more abundant than had been assumed” and despite the economy operating at full employment at a 3.9 per cent unemployment rate, wage cost pressures demonstrated “better balance and inflation expectations remained anchored.”

The Bank highlighted several issues that potentially were working against the fight to get inflation back to target. Those included strength in consumer demand over the Black Friday period, inflationary geopolitical risk and ongoing services inflation.

It also found that despite its restrictive monetary policy, there continued to be strength in back lending to both households and businesses that suggested that the so-called ‘neutral rate’ - an interest rate that is neither expansionary nor contracting - might need to be recalibrated.

“A number of measures of financial conditions had loosened somewhat over prior months and there were indications that financial conditions were not restraining credit growth as much as had been expected,” the minutes said.

“Members acknowledged that this observation could have implications for the appropriate stance of monetary policy.”

“In weighing up the potential implications of these observations for future decisions on the stance of monetary policy, members reiterated their earlier view that they had minimal tolerance to accommodate a more prolonged period of high inflation than currently envisaged.”

Productivity persists as an issue

The RBA continues to be concerned by the impact Australia’s low labour productivity may have on inflation.

It noted the 0.2 per cent per annum productivity growth of the last five years but raised concerns that it was not exclusive to the public sector alone.

Public sector productivity has been cited by analysts as one of the drivers of Australia’s poor record against international peers, but the RBA found that “only a small part of the shortfall between this slow pace of growth in aggregate productivity and its historical average reflected the rising share of labour in the non-market sector.”

“Productivity growth in the market sector had also been around a percentage point below long-run average rates and... there was a broad-based pattern of productivity growth in Australian industries having been below rates recorded by comparable industries in the United States.”

Despite expectations for a February rate cut being pushed out by analysts, the RBA said it would have sufficient data in time for its February rates deliberation.

“Important additional information on the labour market, inflation and expenditure, along with a revised set of staff forecasts, would be available by the time of the February 2025 meeting,” the RBA said.