Interview: Why rate relief could still be 18 months away

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Sean Aylmer: Welcome to the Fear and Greed business interview. I’m Sean

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Sean Aylmer: Aylmer. The Reserve Bank Board yesterday left the official cash

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Sean Aylmer: rate on hold at 4.1% with Governor Philip Lowe saying

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Sean Aylmer: the higher rates are working to establish a more sustainable

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Sean Aylmer: balance between supply and demand in the economy and will

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Sean Aylmer: continue to do so. But he warned that more increases

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Sean Aylmer: might still be needed to get inflation back into its

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Sean Aylmer: target range or at least the reserve banks target range.

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Sean Aylmer: Carlos Cacho is the Chief Economist at Jarden Australia. Carlos, welcome to

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Sean Aylmer: or welcome back to Fear and Greed.

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Carlos Cacho: Thanks for having me, Sean. Good to be back.

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Sean Aylmer: So the big question, do you think the rate rise

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Sean Aylmer: cycle is over or not?

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Carlos Cacho: Look, in our view there’s still the risk is we

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Carlos Cacho: do see more rate hikes. Inflation, while it is slowing,

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Carlos Cacho: is still twice the top of the RBAs target. We are

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Carlos Cacho: still seeing services inflation, particularly in things like rents, insurance,

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Carlos Cacho: utilities increasing at a pretty rapid pace and that’s going

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Carlos Cacho: to make it difficult for the RBA to say anytime

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Carlos Cacho: soon that they’re done hiking rates with a sense of certainty.

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Carlos Cacho: On top of that, we also know the housing market

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Carlos Cacho: is now picking up again miraculously in the face of

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Carlos Cacho: a over 30% fall in how much money people can borrow.

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Carlos Cacho: And so that creates upside risks to the consumer that the

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Carlos Cacho: RBA also has to factor into their thinking.

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Sean Aylmer: So the bank talked about the services’ inflation yesterday, didn’t

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Sean Aylmer: they? Clearly it’s something that is top of mind to them.

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Carlos Cacho: Yes, absolutely. And this is really a global trend we’ve

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Carlos Cacho: seen where goods inflation, particularly in discretionary consumer goods is

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Carlos Cacho: coming back as global supply chains ease. As retailers start

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Carlos Cacho: discounting again. As consumers make it a little bit more

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Carlos Cacho: difficult to get into their wallets. And what’s left running

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Carlos Cacho: and has been quite persistent globally is that services component.

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Carlos Cacho: In Australia, the big driver at the moment is rents,

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Carlos Cacho: which are accelerating towards about 10% year- on- year, which

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Carlos Cacho: is the fastest pace we’ve seen in a very long

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Carlos Cacho: time, and that’s the second- biggest weight in the CPI

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Carlos Cacho: basket. So that has a pretty material impact on the

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Carlos Cacho: headline inflation number.

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Sean Aylmer: The Reserve Bank is famous for what they call jawboning,

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Sean Aylmer: talking up or down rates depending on the economic circumstances

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Sean Aylmer: whilst actually not always doing something. Now the last couple

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Sean Aylmer: of meetings we’ve been on pause, but we keep hearing

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Sean Aylmer: the same commentary, that rates may need to rise. How

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Sean Aylmer: much of jawboning is going on at the moment do

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Sean Aylmer: you reckon?

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Carlos Cacho: Look, they’re going to keep this commentary that the rates

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Carlos Cacho: may need to rise. They’re going to keep their hawkish

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Carlos Cacho: bias or their tightening bias for quite some time in our

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Carlos Cacho: view, as long as there’s still upside risk to inflation,

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Carlos Cacho: which I think is probably going to drag on for

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Carlos Cacho: quite a few months, if not well into 2024, they’re

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Carlos Cacho: going to maintain that guidance because as soon as they

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Carlos Cacho: stop saying that, then the assumption people and the market are going

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Carlos Cacho: to have is that rate cuts are coming soon. And

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Carlos Cacho: so they don’t want that because that would then lead

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Carlos Cacho: to a loosening in financial conditions and potentially a pickup

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Carlos Cacho: in confidence and activity ahead of that rate cuts actually

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Carlos Cacho: being delivered. So they will hold that for a while.

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Carlos Cacho: That said, their tone was a little bit more cautious

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Carlos Cacho: this meeting, and we did see the Aussie dollar soften

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Carlos Cacho: a little bit yesterday and we saw bond yields a

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Carlos Cacho: little bit lower and equities a bit higher. So that

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Carlos Cacho: suggests it was a little bit more dovish as we

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Carlos Cacho: say, or a little bit more cautious than what the

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Carlos Cacho: market was expecting going in.

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Sean Aylmer: The other thing, Carlos Cacho from Jarden Australia, is have they

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Sean Aylmer: changed their forecast on inflation? Because they said that it

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Sean Aylmer: will be back in the two to 3% range or

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Sean Aylmer: won’t be back in that until late 2025. I think

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Sean Aylmer: previously they were mid 25.

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Carlos Cacho: Look, they didn’t really change their forecast much at all

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Carlos Cacho: this meeting. We’ll get the full suite of numbers on

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Carlos Cacho: Friday when they release their quarterly forecasts. But what we

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Carlos Cacho: saw today is they still expect inflation to moderate to

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Carlos Cacho: about three and a quarter percent by the end of

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Carlos Cacho: next year, which is consistent with what their forecast was

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Carlos Cacho: in May. And now, they’ve extended their forecast profile out

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Carlos Cacho: an extra six months to the end of 2025 and

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Carlos Cacho: they now expect inflation to be within the two to

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Carlos Cacho: 3% band. So it doesn’t really look like there’s been

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Carlos Cacho: any change in their actual forecast aside from just extending

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Carlos Cacho: the term.
And their final forecast was 3% in June

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Carlos Cacho: 2025. So the natural assumption would be, well, the second

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Carlos Cacho: half of 2025, it’s going to be below 3%. So

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Carlos Cacho: it’s not really telling us anything new, which in itself

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Carlos Cacho: is a little bit surprising given the CPI outcome from

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Carlos Cacho: the quarterly data we got last week was actually softer

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Carlos Cacho: than they and the market expected. And so I think

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Carlos Cacho: that really highlights the upside risk they still see to

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Carlos Cacho: services inflation as well as the fact that they are

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Carlos Cacho: still likely to maintain this hiking or tightening bias for some

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Carlos Cacho: time given their caution around that.

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Sean Aylmer: Stay with me, Carlos, we’ll be back in a minute.

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Sean Aylmer: I’m speaking to Carlos Cacho, Chief Economist at Jarden Australia.

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Sean Aylmer: What about the labour market? It remains very strong. How

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Sean Aylmer: much you think that’s playing into the reserve bank’s thinking

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Sean Aylmer: at the moment?

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Carlos Cacho: Oh, that’s definitely a big challenge for the reserve bank’s thinking.

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Carlos Cacho: We know that wages are picking up now, we’re still

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Carlos Cacho: yet to see the impact of things like the large

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Carlos Cacho: minimum wage increase in the CPI data and unemployment is

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Carlos Cacho: holding at a 50- year low. The leading indicators, things like

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Carlos Cacho: job ads are softening a little bit, but they still

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Carlos Cacho: remain very strong versus history. So the RBA is probably

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Carlos Cacho: hoping that they can deliver a moderation in inflation while

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Carlos Cacho: keeping unemployment relatively low versus history and we’ll just have

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Carlos Cacho: to wait to see how that pans out. But the

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Carlos Cacho: risk is with a really tight labour market still persisting,

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Carlos Cacho: you could get higher wages growth and that’s going to

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Carlos Cacho: put more pressure on services inflation, which is exactly what

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Carlos Cacho: they’re worried about. Now the other hard thing for the

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Carlos Cacho: RBA is productivity just isn’t there. And without productivity growth,

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Carlos Cacho: that means that the unit labour costs, which is basically

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Carlos Cacho: the cost of labour for producing a standard unit of

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Carlos Cacho: output are rising at a record level. And so that’s

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Carlos Cacho: putting upward pressure on inflation as well. So the RBA

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Carlos Cacho: likes to say that wages are consistent with the CPI

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Carlos Cacho: target if productivity increases back towards where it was pre-COVID.

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Carlos Cacho: The problem is productivity isn’t increasing to anywhere near where

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Carlos Cacho: it was pre-COVID and it’s actually deeply negative at the moment.

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Sean Aylmer: I want to also ask you about house prices because

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Sean Aylmer: the core logic figures came out yesterday in terms of July,

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Sean Aylmer: house prices are still rising and if you take Sydney as

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Sean Aylmer: the leading market, just in terms of leading the market,

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Sean Aylmer: the heat does seem to have come out of it

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Sean Aylmer: just a little bit.

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Carlos Cacho: Look, we’ve definitely seen a moderation in the strength of

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Carlos Cacho: the housing market over the last couple of months. May and June,

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Carlos Cacho: auction clearance rates were in the 70s, they’re back down

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Carlos Cacho: to the mid-60s again. The pace of monthly price growth

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Carlos Cacho: has moderated over 50% from where it was. We were

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Carlos Cacho: seeing 1% plus outcomes, we’re now back below 1%. It’s still

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Carlos Cacho: surprisingly resilient in the face of higher rates. Our expectation

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Carlos Cacho: remains that rates are going to remain high for longer

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Carlos Cacho: than expected and that is eventually going to take the

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Carlos Cacho: wind out of the sails of the housing market. But

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Carlos Cacho: that’s crucially going to depend on more supply coming on.

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Carlos Cacho: And one of the biggest drivers at the moment is

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Carlos Cacho: just that there’s so little stock on the market. So

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Carlos Cacho: even though demand might be relatively soft versus normal conditions,

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Carlos Cacho: there’s so few houses available that people are still having

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Carlos Cacho: to bid up to win them. What we are starting

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Carlos Cacho: to see now though is the unusual seasonal pattern where

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Carlos Cacho: listings are already starting to rise and in particular they’re

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Carlos Cacho: starting to rise for units and ex-investment properties. So we’re

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Carlos Cacho: actually seeing the highest share of investor sales in Sydney

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Carlos Cacho: in particular on record about 40% of listings in June

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Carlos Cacho: and July were in former investment properties. And we think

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Carlos Cacho: that supply coming online could potentially drive a bit more

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Carlos Cacho: of a softening in the housing market late this year

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Carlos Cacho: and into early next year.

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Sean Aylmer: Bringing all this together, interest rates, inflation, employment, housing market,

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Sean Aylmer: do you think that the Australian economy can land over

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Sean Aylmer: the next 12 months without going into recession? The so-called

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Sean Aylmer: soft landing, it would be quite a feat? Well, I

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Sean Aylmer: think six months ago we would’ve said it would be

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Sean Aylmer: quite a feat. Maybe we won’t say that now, but

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Sean Aylmer: where do you think we are? How do you think

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Sean Aylmer: we’ll be in the next 12 months?

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Carlos Cacho: Look, a recession is a risk. It always is. It’s

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Carlos Cacho: never been our best case though. And I think when

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Carlos Cacho: I look at the economy as a whole, there are

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Carlos Cacho: pockets that are in pain, discretionary consumer spending is clearly

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Carlos Cacho: under pressure. But if we look broader than that, if

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Carlos Cacho: we look at things like business investment, exports, the construction

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Carlos Cacho: sector is still doing very well. Yes, residential construction will

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Carlos Cacho: come off next year, but excluding residential construction, there’s still

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Carlos Cacho: a massive pipeline of both public and private work to

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Carlos Cacho: be done and just government spending. As much as the

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Carlos Cacho: government is showing restraint in not spending this big 20

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Carlos Cacho: billion surplus that they’re building up, in the face of

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Carlos Cacho: cost of living pressures, there’s still a lot of spending

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Carlos Cacho: going out the doors. And so I think in the

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Carlos Cacho: end we probably will avoid a recession, but that probably

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Carlos Cacho: means rates are going to remain higher for longer.
And I

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Carlos Cacho: think this is the key thing people need to start

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Carlos Cacho: thinking about. It’s no longer about where the peak is

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Carlos Cacho: going to be for rates. There might be one or

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Carlos Cacho: two more hikes to come, there might not. But in

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Carlos Cacho: our view, I think the more important factor is going

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Carlos Cacho: to be how long do we stay at these levels

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Carlos Cacho: and we expect we’re going to remain at the current

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Carlos Cacho: cash rate or higher until at least the end of

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Carlos Cacho: next year. So we think it could be quite a

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Carlos Cacho: while before we get relief of rate cuts coming through,

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Carlos Cacho: particularly if the economy remains surprisingly resilient.

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Sean Aylmer: And Carlos, I can’t let you go without asking about

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Sean Aylmer: the bank side because I know you’re the bank’s analyst

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Sean Aylmer: at Jarden Australia as well, just with earning season coming

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Sean Aylmer: up, the three of the big four don’t actually report.

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Sean Aylmer: They’re on a different cycle, but Commonwealth Bank does report.

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Sean Aylmer: This earning season, I suppose I’m referring really to Commonwealth

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Sean Aylmer: Bank, what’s the sort of stuff you are looking for

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Sean Aylmer: from reporting season?

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Carlos Cacho: Look, really the two key things that the market’s going

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Carlos Cacho: to be focusing on is first of all margins and

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Carlos Cacho: how bad the fallen margins is. The market is hoping, I

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Carlos Cacho: think, for a bit of a moderation, things being less

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Carlos Cacho: bad there than they were in the third quarter. And

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Carlos Cacho: the other thing will be if there’s any signs of

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Carlos Cacho: bad debts picking up and there we expect that things

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Carlos Cacho: are going to remain pretty benign in a lot of

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Carlos Cacho: the research we do, looking across the economy, across businesses,

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Carlos Cacho: we really struggle to see much in the way of

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Carlos Cacho: red flags for rising bad debts or business stress or

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Carlos Cacho: household stress from the banks.
People are under pressure, yes,

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Carlos Cacho: but it’s not yet leading to loan arrears or defaults.

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Carlos Cacho: And we got another important piece of data out on

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Carlos Cacho: that actually yesterday with Credit Corp who’s a debt collector

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Carlos Cacho: reporting and actually saying that that lack of pain on

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Carlos Cacho: the credit side is actually, it’s bad for them. They’re

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Carlos Cacho: not seeing as much as debt come through to them

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Carlos Cacho: to collect as they would normally expect in this kind

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Carlos Cacho: of environment. So I think if we do get a

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Carlos Cacho: soft landing that’s going to end up being a positive

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Carlos Cacho: for the banks.

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Sean Aylmer: Carlos, thank you for talking to Fear and Greed.

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Carlos Cacho: Thanks for having me, Sean.

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Sean Aylmer: That was Carlos Catcho, Chief Economist at Jarden Australia. This

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Sean Aylmer: is the Fear and Greed business interview. Remember, this is

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Sean Aylmer: general information only and you should seek professional advice before

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Sean Aylmer: making any investment decision. Join us every morning for the

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Sean Aylmer: full episode of Fear and Greed. Australia’s best business podcast.

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Sean Aylmer: I’m Sean Aylmer. Enjoy your day.