According to his retelling of events, he did challenge her on the matter. We don't have the original conversation to judge for ourselves but he does explain that in talking to Josh and Sam, he's repeating his expression of frustration that he's already made to Estelle.
This is the crux of the matter. Estelle has done this before. Rather than engaging in conversation she's struck an ultra PC pose. Instead of freely interacting, she's fished for a moment to stand some moral high ground. That would be a really frustrating thing to have to deal with.
Of course Michael wants to remonstrate about it. Of course he doesn't want people to miss the context of what he's said and only hear him sounding racist. He's wrong to call Estelle thick but in a way that's kinder than to attribute to her the self aggrandising bit of high horse play she chose to indulge in.
Michael's fuming and rightly so. I can only guess his annoyance is largely because Estelle failed to assure him that she did understand where he was coming from after all. That is the indication of her not getting the context. Instead, it sounds like she kept her nose in the air about not wanting to hear 'that sort of talk'.
This is not about Estelle not appreciating a racist joke. There wasn't a racist joke. It sounds like she decided to make it into being about a racist joke. It is extremely offensive to tell someone they're being racist when they're not.
Yes, I'm looking at you hawkeye99.
We have no indication whether she engaged in a conversation or not. Whether she understood or not. You're just assuming she didn't.
We are told she said it was "unnecessary and offensive" as part of Michael ranting at how stupid she is.
According to the events, she said that, then Michael stopped and explained why he said it. We have no indication or suggestion as to what she said after he stopped and explained himself in response to her comment.
She might have said, "yes, Ok, I still don't think it's necessary to tell such an offensive joke."
or
"No there's never an excuse."
or
"I understand, sorry."
We don't know and i'm sorry, but there isn't any indication in the clip. He is just complaining about her saying the joke was unnecessary may have
in that moment have made him look bad. Which clearly goes to how he sees that it could have made him look bad. Which further justifies Estelle saying it's unnecessary. She didn't think it was, he clearly sees others could also think that. It is all about him throwing a tantrum about maybe looking bad and then calling her an idiot for it.
Not everyone likes and can appreciate racist jokes for non racist reasons. There is nothing wrong with that at all. From her perspective, she's heard him say the same racist joke twice now. I guarantee, if we ever see the clip. There will be a joking tone, taking enjoyment out of telling the joke. That doesn't mean he's a bigot. People can enjoy racist jokes on different levels. Some because they are racist. Others because the punchline is not the racism but how offensive the racism is or can be perceived. I am sure Michael is in the later camp. Which I would generally classify myself in.
His rant is about no wrong doing or stupidity of her. It is about Michael thinks he is awesome and super smart. That no one should challenge him, no one should question him. They should all sit there and agree, he's a genius after all. He is upset she wasn't a passive listener, then even more upset by making a comment he could come off badly.