A subtle but noteworthy change has recently surfaced in statements from the Reserve Bank of Australia. It has discarded the reassuring narrative that medium-term inflation expectations are steadfastly anchored at a level consistent with the target, transitioning instead to a vigilant stance regarding a potential rise in these expectations.
Why this rhetorical shift, you might ask? The answer lies, as it often does, in the data.
RBA's published data on inflation expectations surveyed from various stakeholders, including consumers, businesses, union officials, market economists, and a measure extracted from financial markets. While there can be discrepancies, such as the persistently exaggerated expectations of households, a general consistency prevails, especially when considering insights from union officials and market economists whose day job often involves the evolution of prices and wages over time.
However, this conventional harmony has taken a worrisome turn, with both groups projecting increasingly divergent forecasts.
In RBA we trust
Surprisingly, market economists demonstrate a greater conviction in RBA's inflation targeting abilities than the bank itself!
Traditionally market forecasts for one- and two-year ahead inflation have been closely aligned with the midpoint of RBA's target band. However today's inflation-ridden climate has reshuffled expectations, with market economists projecting the inflation rate to reach about 3.3% over the next year and to moderate to 2.7% in two years.
By comparison the RBA's May SMP forecasts place these figures even higher at 3.6% and 3%, respectively.
It’s hard to see why the market economists would be more optimistic than the RBA itself - perhaps the survey is not eliciting their actual views and they are answering with their heart rather than their head.
The S word
More concerning is the increasingly unanchored expectations of union officials. The most recent survey of ACTU members revealed that they anticipate inflation to linger around 5% for the next year, reducing only to 4% in two years time. These estimates exceed both the RBA's targets and its own inflation projections by a significant margin.
This divergence in inflation expectations matters to the RBA, given the role union officials play in wage bargaining processes. Their participation in minimum and award wages deliberations and the negotiation of enterprise bargaining agreements is pivotal. An entrenched belief in a 4-5% inflation rate over the upcoming years can heavily influence their bargaining strategy, potentially strengthening demands for higher nominal wages.
This explains the RBA's apprehension regarding the persistently high inflation rate and it hints at possible further hikes in interest rates. Stabilising inflation back within the 2-3% band without generating a full blown recession requires a consensus among economists, union officials, businesses, and households about the expected inflation rate over the next few years - a consensus that has yet to be achieved.
Ironically, despite being (rightly) dismissive of the existence of a wage-price spiral, their surveyed beliefs are similar to what you would expect to see if a wage-price growth loop became entrenched.
The ACTU have been pretty vocal critics about the current approach of increasing interest rates. It would be ironic if it is their surveyed expectations that gives the RBA another reason to keep going.