RBA Board Minutes present balanced view
The Minutes to the September meeting are clear that a move to 25’s is near but, in our view, not by October.
The Minutes of the Reserve bank Board’s September meeting provide a balanced view of the outlook for policy.
It is important to note that this Board meeting occurred before the release of the US Inflation Report which was responsible for lifting the outlook for the federal funds rate and, arguably, global rate settings.
For example, Westpac lifted its forecasts for the terminal federal funds rate from 3.375% to 4.125%.
That was a clear signal that global interest rates were heading higher than expected at the time of the Board meeting – the Minutes already noted that “central banks in most advanced economies had been increasing policy rates at a rapid pace.”
The discussion on the deliberations on policy noted that “the Board discussed the arguments around raising interest rates by either 25 basis points or 50 basis points”. That compared with the August Minutes that did not refer to a discussion of 25 basis points – just the 50 basis points which was the decision. The August decision referred to “continue the process of normalising monetary conditions.”
In explaining the decision in September, the Board put forward that “price stability is a prerequisite for a strong economy.” But acknowledged the lags in the system. The key decision point was “Given the importance of returning inflation to the target, the potential damage to the economy from persistent high inflation and the still relatively low level of the cash rate.”
In the key final paragraph, the Board noted (unlike in August) that “All else equal, members saw the case for a slower rate of increase as becoming stronger as the level of the cash rate rises.”
While that last sentence is making an obvious point the fact that the Board chose to include it in the important final paragraph must be taken very seriously.
Certainly, if we are correct, and the Board chooses to lift the cash rate by a further 50 basis points in October to 2.85% – comfortably above the Governor’s previous assessment of neutral, then the moves thereafter, and we expect three more, will be at the slower pace of 25 basis points.
On balance, given that the Board has given much greater emphasis in these Minutes to the lags in the system consistent with an imminent slowing but not necessarily immediate slowing.
It is also important that the Minutes note, “The Board was resolute in the need to ensure that inflation returned to target, but was mindful that the path to achieve this needed to account for the risks to growth and employment” But that theme is not new. Consider the August Minutes, “The size and timing of future interest rate increases will be guided by the incoming data and the Board’s assessment of the outlook for inflation and the labour market, including the risks to the outlook.” The theme is emphasised more strongly in these Minutes as you would expect but not enough to exclude one more “50” in October.
Certainly, the assessment of the economy remains upbeat – “inflation high and broadly based”; “some retailers expect to apply further large increases in their prices in the coming quarters”; “household spending appears to have held up in the September quarter to date”; “consumption behaviour was changing only slowly in response to cost of living pressures”; “the outlook for business investment remained positive”; “non mining capacity utilisation at its highest level in over three decades”; “demand for labour remained robust”; “wages growth was picking up as expected”.
The Board was also presented with the Bank’s assessment of the success of the Bond Purchase Program (BPP). The assertion was that “It is difficult to identify the exact effect of the BPP … because it was implemented as part of a broader package of policy measures”.
While the Board recognised the financial cost to the Bank’s balance sheet (some time ago when rates were below current levels Westpac estimated a mark to market “loss” of $37 billion) it noted, correctly, that the loss should be interpreted in the context of wider benefits to the economy, including the benefits to the public balance sheet (lower borrowing costs) and the boost that lower rates would give to the economy. The accounting loss to the Bank would be partly offset by the benefits to the public balance sheet of lower borrowing costs – but by their own admission they cannot quantify the effect on rates of the program.
Suffice to infer from the conclusion, “In light of the experience members judged it appropriate to consider use of the BPP again only in extreme circumstances when the usual monetary tool – the cash rate has been employed to the full extent possible”.
In summary we can calculate the cost of BPP while the benefits are not quantifiable.
Conclusion
It has been Westpac’s view that the greater “evil” of the current economic settings is to lose control of inflation and inflationary expectations.
We think that will only be achieved with a significant slowdown in the economy from 3.4% growth in 2022 to 1% growth in 2023.
The Board will have to accept a downturn in growth and employment and it is unlikely it will be able to bring inflation back without compromising the “even keel”, which t has favoured in today’s Minutes as on previous occasions.
While these Minutes certainly give more emphasis on the risks to the real economy of the current policy approach it does not appear, certainly after the recent upward recalibration in global rates that it will see that, with the cash rate at 2.35%, and still in “expansionary territory” it is time to slow down the tightening pace.
We confirm our view that the cash rate should and will be increased by 50 basis points in October and that the terminal rate will be 3.6%, reached in February next year.
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