April Minutes indicate the RBA Board is open to May rate increase
The Board makes a solid case for higher rates but still data dependent.
The Minutes of the Reserve Bank Board’s April meeting show that the Board is leaving its options open to raise the cash rate or pause at the May Board meeting.
The case for an increase is much stronger than was the case for the April meeting.
There are three subtle clues here.
Firstly, unlike the Minutes in March, the Board did not specifically commit to considering a pause at the next meeting.
Secondly, it qualifies the message from market pricing which is pointing to an extended period of rates on hold “as was the case abroad market pricing reflected an average of both upside and downside scenarios”.
Finally ,the preference for higher rates is implied in the comment , “Members noted that the forecasts produced by the staff in February had inflation returning to target range only by mid-2025 and that it would be inconsistent with the Board’s mandate for it to tolerate a slower return to target. These forecasts were conditioned on monetary policy being tightened a little further.”
This comment is somewhat disturbing – calibrating policy on the basis of a two year forecast seems risky – better to give more weight to the “here and now” and, as we see in the Minutes, “Inflation remained too high, the unemployment rate was very low and surveyed business conditions were still strong”.
The Board also raises a number of “new” arguments which point to upside inflation risks and support the case for tightening policy further.
Firstly, the lift in near term population projections; “could put significant pressure on Australia’s existing capital stock, especially housing, which would in turn manifest in higher consumer prices”. The recent stabilisation of the housing market is also mentioned, “recent fall in housing prices might be smaller and more short lived than expected.”
Secondly, “increased risk of larger wage increases in parts of the economy, including the public sector.”
But the key to the decision in May relates to the motive for the pause in April.
Westpac was very confident of the April pause because the argument, “to gather more information on the economic outlook” made the delay until May quite predictable.
Since the April meeting the Board’s “check list”, so far, has supported a rate hike.
Concerns about a global banking crisis have been largely allayed, although we do expect that credit conditions, particularly in the US, will tighten markedly. However, signals from the FOMC point to a commitment to a further rate increase in May – two days after the RBA Board meeting.
Business conditions and business / consumer confidence may have tumbled in March/April given the weak household sector. In the event business conditions held at a very healthy +16 while there was a lift in business confidence and Consumer Sentiment surged by 9.4%.
There was the issue of the strength of the labour market. The bounce back in February (unemployment rate down to 3.5%) could have purely reflected the seasonality from the collapse in January. That fear was allayed with an additional 53,000 jobs in March and a consolidation of the 3.5% unemployment rate.
A key piece of information will be the next print of underlying inflation (Trimmed Mean) with the March quarter inflation report. The monthly inflation gauge does not provide a measure for the Trimmed Mean. It was the unexpected lift in the annual Trimmed Mean Inflation rate to 6.9% in the December quarter, compared to RBA forecast of 6.5%, that triggered an upward revision to the RBA’s inflation forecasts and the hawkish response in the February Board Minutes.
The staff forecasts, which point to the mid-2025 achievement of the inflation target, are for the Trimmed mean annual inflation to fall from 6.9% in December to 6.2% in June, implying an expectation of around 6.5-6.6% in the annual Trimmed Mean in March. A number significantly above that forecast would, presumably, put some doubt on the staff’s two year path back to target and certainly see a response from the Board at the May meeting.
The interest profile used for the refreshed forecasts is an average of market pricing and market economists’ forecasts. That profile will be lower than the profile used in February but still imply a little more tightening in the near term due to the market economists being more hawkish than the market.
Overall, the Minutes note that “this suite of additional information (before the May meeting) would be valuable in assessing the economic outlook and the extent to which monetary policy would need to be tightened further”.
Although that passage points a short pause, the pause motive might be to take longer to assess the impact of the tightening cycle.
The comment, “pausing…. would be consistent with the typical pattern of policymaking before the pandemic” can be interpreted in two different ways – take an extended pause or time policy moves to follow the quarterly inflation update (as was the case in previous tightening cycles). Pausing in May would imply waiting for a further quarterly inflation update at the August Board meeting. The risk with that, with rates on hold for four months with the current inflation and unemployment profile, is that inflation and inflationary expectations may have built up unnecessarily.
Conclusion
The ultimate decision in May will be a value judgement from the Board and the Inflation report for the March quarter will be important.
A reasonable interpretation from the Minutes of the April meeting is that a further increase of 0.25% is a much more realistic outcome in May than was the case in April.
That increase in May remains Westpac’s view.
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