Market is not reacting to the data
The RBA has adopted a dovish tilt – the data is telling a different story.
It has been interesting to follow market pricing with respect to the expected RBA cash rate by June next year.
Even though market pricing has rates trending a little higher in the second half of 2023 I think that is more about the market giving, say, a 20% chance that the RBA will need to continue raising rates in the second half due to a dangerous resistance of inflation to the extremely likely collapse in economic activity at that time.
The real issue is how far markets expect the cash rate to rise by June next year with economic activity holding much firmer than in the second half and inflation easing but at what pace?
Westpac expects that the inflation pulse will be sufficiently strong in the first half of 2023 for the RBA to see the need for the cash rate to be lifted, for the final time, to 3.85% by May.
Until last week market pricing was a little higher than that target rate but has since pulled back to a target rate of 3.6%.
That 25 basis point pull back can be largely attributed to the market’s assessment of comments by Deputy Governor Bullock to a Senate Committee on November 10 (15 basis points) and the lower than expected US inflation print for October (8 basis points).
The Deputy Governor’s comments were backed up by the Minutes of the November board meeting.
The Minutes included a comment, “the Board is prepared to keep rates unchanged for a period while it assesses the state of the economy and the inflation outlook.”
Further, the description of the interest rate outlook is also moderated, somewhat.
“The Board … expects to increase interest rates further over the period ahead.” (November) compared to “likely to require further increases in interest rates over the period ahead.” (October).
The concept of “drawing out policy adjustments would also help to keep public attention focussed for a longer period on the Board’s resolve to return inflation to target”, which figured in the October Minutes is not used in these Minutes - trying to lower the expectations for the peak in the terminal rate, perhaps – as anticipated by the adjustment in market pricing over the previous week.
The Board also provided a somewhat confusing sequence in the Minutes when it praised the concept of stability in policy making.
The Minutes noted the advantage of hiking by 25 basis points in November after having scaled back to 25 basis points in October as “acting consistently would support confidence in the monetary policy framework among financial market participants and the community more broadly.”
But that observation was followed by the assertion (as has appeared in earlier Minutes), “The size and timing of future interest rate increases will continue to be determined by the incoming data and the Board’s assessment of the outlook for inflation and the labour market.”
The Minutes also noted that “the September quarter inflation data were a little above the Bank’s forecast”. That statement certainly contrasted with our own assessment that the data was significantly higher than ours and the market’s forecast (underlying inflation printed an actual of 1.8% against an expected 1.5%).
It also prompted a sizeable upward revision to the Bank’s own forecast for underlying inflation in 2022 from 6.0% to 6.5% but did not see a further revision to the 2023 forecast for underlying inflation for 2023.
With the clear evidence from the Report that inflation pressures were becoming even more broadly based (nearly 80% of the components of the CPI basket grew by more than 3% over the year) it was surprising that the underlying inflation forecast for 2023 was not appropriately increased.
So, it does seem somewhat surprising that in the face of the need to lift the underlying inflation forecast for 2022 (Headline inflation was lifted from 4.3% to 4.7% in 2023, largely in response to the government’s advice that electricity prices are expected to increase by 56% over the next two years) the rhetoric from the Board and the Deputy Governor took an opposing dovish tilt.
Perhaps that approach was in anticipation that the data associated with the labour market would support a more dovish tilt to the policy outlook – even going so far as some analysts anticipated that the “pause” could occur as early as the December meeting.
But the wages and employment reports were certainly not supportive of an imminent pause.
Wages growth (Wage Price Index) lifted by 1.0% (seasonally adjusted) in the September quarter, the highest quarterly growth recorded since the March quarter 2012, primarily driven by private sector wages which lifted by 1.2%, for an annual rate of increase of 3.4%.
Those receiving a wage increase in the private sector in the September quarter, some 46.4%, saw their wage increase by 4.3%.
While it was anticipated that the driving force behind the result would have been the award sector (a range of 4.6% increase for some awards - 5.2% for the minimum wage/other awards) the dominant driver was “individual bargaining agreements” increases which contributed 57% of the increase compared to awards (15% contribution) and enterprise bargaining (28% contribution).
In level terms the individual bargaining contributed 0.80ppt to the quarterly increase (of the non-seasonally adjusted estimate of wages, which rose by 1.4% in the period), up from in the equivalent quarter in pre Covid periods (0.34ppt September 2019; 0.33ppt September 2018 ; 0.36ppt September 2017).
Finally, we are seeing the slow-moving Wage Price Index capturing some of the effects that we have already seen in business surveys, including the RBA’s own liaison.
Westpac expects growth in the Wage Price Index to reach 4.5% in 2023, compared with the RBA’s current estimate of 3.9% (revised up from 3.6% before the recent release). Reasonably one would expect that the RBA will be reviewing that forecast for its next Statement on Monetary Policy in February next year.
The Employment Report was released on November 17. It was also a strong report.
Employed people increased by 32,200 and the unemployment rate fell from 3.5% to 3.4% (a 50 year low). Employment had fallen in aggregate by 4,000 over the three previous months (July, August and September) and there were concerns that demand in the labour market was weakening. On the other hand, weak jobs growth could be attributable to restricted supply. One source of that restricted supply would be “own illness or injury or sick leave”. In recent months the number of employed people working fewer hours for those reasons had lifted from around 400,000 to a touch more than 780,000. That showed up in restricted hours worked.
In October that number fell back to around 470,000 and hours worked rose by a sharp 2.3% in the month – outcomes which certainly shifted the explanation for the “soft patch” in the jobs market over the previous 3 months from demand to supply.
The Unexpected Reaction of Markets
Despite this fairly clear evidence that the RBA has significantly more work to do, markets have not responded, with the net 25 basis point fall in rates since the Deputy Governor’s speech last week holding firm.
We do not think the RBA will see this week’s developments in such a way.
The evidence that tight labour markets and very high inflation will extend into 2023 has become clearer.
A central bank, confronted with such developments, which decides to pause can only do so on the basis of clear confidence in their forecasts that inflation is set to ease significantly.
We expect that pre-emptive policy based on forecasts is unlikely to be the preferred option of this central bank and markets should heed that warning.
Westpac continues to expect 25 basis point increases in the cash rate in December; February; March and May for a terminal rate of 3.85% (around 30 basis points above the market’s outlook for May).
Bill Evans, Chief Economist
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