The release of the Statement on the Conduct of Monetary Policy agreed between the Treasurer and the RBA Board marks the next step in the response to the RBA Review earlier this year. The changes are in line with the Review recommendations. We expect the February post-meeting communication to include unattributed votes and much more detailed forecasts.
Recently a parliamentary committee released a report into a central bank’s performance. It concluded that the central bank in question had made significant errors in its conduct of monetary policy in recent years. It expressed concerns about a ‘perceived lack of intellectual diversity’ in the central bank and a culture of ‘insufficient challenge’. It critiqued the overly broad and vague mandate, arguing that a ‘democratic deficit has emerged’, where ‘critically important economic decisions are delegated to unelected officials’. The report therefore called for a five-yearly review of that central bank’s remit.
While this might sound familiar in the context of the RBA Review released earlier this year, the report was in fact by the UK House of Lords Economic Affairs Committee, about the Bank of England.
The RBA has also been through the review process recently, with very similar findings and recommendations. Today’s release of a refreshed Statement on the Conduct of Monetary Policy marks a further step in the response to that review; the previous Statement was released in September 2016, when the previous Governor took over. There are few surprises in the new document, but several noteworthy changes.
The first comes in the first paragraph. Rather than recording the common understanding of the Governor as Chair of the RBA Board, and the Government, the new Statement frames this common understanding as being of the Board as a whole and the Government. This lines up with the thrust of the RBA Review’s recommendations to make the Board have more ownership and accountability for monetary policy decision rather than centring all the focus on the Governor. Other changes in this vein include the publication of unattributed votes, and of Board papers with a five-year lag. This shift also presumes that the Board will have more capacity to challenge the Governor and staff.
A further layer of challenge comes from the changes to the appointment process for Board members. Currently nominations come from a register of ‘eminent candidates’ maintained by the Secretary of Treasury and the Governor. The new Statement adds an ‘independent third party’ to the group maintaining a ‘shortlist of candidates’ who should have the ‘right balance of skills and experience to best discharge [the Board’s] functions’. The RBA Review suggested that the third party could be an outside expert, but they could also be a past Board member or the Chair of the Governance Board. Since the Governor is to be the Chair of the Governance Board, this third nominator needs to be an outsider. The Statement was not the place to give examples of who that could be. If not a former Board member, though, the creation of this role removes somebody from the pool of potential Board members.
Similarly, the expert advisory group on monetary policy to be convened by the Board presumes that there are enough such (unconflicted) outside experts available to serve. Expect at least some of these experts to be drawn from overseas, and so be less expert about the differences between Australia’s institutions and those abroad.
The revised Statement does not change the RBA’s flexible inflation target in a material way. The 2–3% band is validated, with the Statement declaring that ‘all outcomes within the target range are consistent with the Reserve Bank Board’s price stability objective.’ In the very next sentence, the Statement goes on to say, ‘The Reserve Bank Board sets monetary policy such that inflation is expected to return to the midpoint of the target.’ This could be interpreted as mandating that policy should always be set so that the endpoint of the inflation forecast should be 2.5%. Since that is not currently the case, some observers might think this implies that the RBA now needs to get inflation down faster than its recent statements imply, with hawkish implications for interest rates.
In our view that would be a misreading of the intent of this change. The length of the RBA’s published forecasts has been defined by the capacity of its past forecasting technology. As modelling approaches have improved and expanded, it is entirely possible for the RBA to publish a longer horizon for its forecasts and show inflation returning to 2.5% on a longer trajectory.
We can therefore expect the RBA to start publishing longer-run forecasts, at least from time to time. In doing so it will need to decide how to represent uncertainty around those longer horizons. These RBA currently does this by showing error bands around its forecasts based on its own past forecast errors. This is good practice, but it cannot be done for forecast periods that go beyond the length of its past published forecasts. A new, perhaps hybrid, approach must be found.
Along with longer forecasts, the Statement announces that the RBA has agreed to publish more detailed forecasts, including assessments of potential output and full employment. It should be noted that in the past the RBA has not tended to emphasise the unobserved concept of potential output and the output gap in its communication. This shift will bring it more into line with practice at some other central banks. How that fits in with the intent to reduce groupthink remains to be seen.
Consistent with the recommendations of the RBA Review and the proposed changes to the Reserve Bank Act, the Statement clarifies the Bank’s full employment objective to be ‘sustained full employment, which is the current maximum level of employment that is consistent with low and stable inflation.’ This is essentially the NAIRU (non-inflation accelerating rate of unemployment) from economic theory. The Statement’s recognition that ‘full employment is not directly measurable and changes over time’ is therefore welcome.
The financial stability responsibilities of the RBA have been revised as well, though the substance of the section is little changed. The Statement does not mention the RBA’s role as chair of the Council of Financial Regulators and the text could even be read to imply that the RBA need not be a member. While we do not regard that as the Statement’s actual intent, it is an interesting omission.
Since the publication of the previous Statement in 2016, the RBA has joined the ranks of central banks that have used unconventional policy tools such as Quantitative Easing (that is, buying bonds and other assets). These policy tools sparked considerable concern in the House of Lords report, but in the Australian context, the Government has been content for the Board to ‘use its judgement to determine what these tools are, when they are needed and how they are to be deployed most effectively.’ To ensure transparency and accountability, in the Statement the Board undertakes to ‘communicate a framework to guide the use of additional monetary tools, including the benefits, costs and risks associated with available tools.’ No timetable is set for the publication of this framework. Much of this work had already been done and articulated in speeches and other public documents. We can nonetheless expect to see more formalised and structured documents capturing any new analysis on these issues.
The other main set of changes in the Statement relates to the role of Treasury. For all the language added to the first section about the importance of the RBA’s independence, the Review and the new Statement tighten the relationship between the RBA and Treasury. Some of this is welcome, for example the commitment to work together to better understand the joint effect of monetary and fiscal policy. Setting out an explicit responsibility for the Secretary to the Treasury to ‘provide independent insight on the outlook for the economy and fiscal policy’ is also welcome as good practice. But there are other areas where the increased role of Treasury has less obvious benefits. For example, the Statement sets out that there shall be a review of the RBA’s monetary policy framework and tools every five years. Unlike other central banks’ regular reviews, this will be done jointly with Treasury. This sits uncomfortably with the concerns expressed by the House of Lords about the Bank of England being overly dominated by UK Treasury perspectives and former Treasury staff.
Based on the revised Statement, we expect to see more detailed – and possibly longer – forecasts in the February Statement on Monetary Policy, and unattributed votes in the February decision statement. The formation of the expert panel and independent member of the Board appointment panel will probably take a little longer.
©2023 Westpac Institutional Bank is a division of Westpac Banking Corporation ABN 33 007 457 141, AFSL233714 (‘Westpac’). References to the “Westpac Group” are to Westpac and its subsidiaries and includes the directors, employees and representatives of Westpac and its subsidiaries.
Things you should know
We respect your privacy: You can view our privacy statement at Westpac.com.au. Each time someone visits our site, data is captured so that we can accurately evaluate the quality of our content and make improvements for you. We may at times use technology to capture data about you to help us to better understand you and your needs, including potentially for the purposes of assessing your individual reading habits and interests to allow us to provide suggestions regarding other reading material which may be suitable for you.
This information, unless specifically indicated otherwise, is under copyright of the Westpac Group. None of the material, nor its contents, nor any copy of it, may be altered in any way, transmitted to, copied of distributed to any other party without the prior written permission of the Westpac Group.
This information has been prepared by the Westpac Institutional Bank and is intended for information purposes only. It is not intended to reflect any recommendation or financial advice and investment decisions should not be based on it. This information does not constitute an offer, a solicitation of an offer, or an inducement to subscribe for, purchase or sell any financial instrument or to enter into a legally binding contract. To the extent that this information contains any general advice, it has been prepared without taking into account your objectives, financial situation or needs and before acting on it you should consider the appropriateness of the advice. Certain types of transactions, including those involving futures, options and high yield securities give rise to substantial risk and are not suitable for all investors. We recommend that you seek your own independent legal or financial advice before proceeding with any investment decision. This information may contain material provided by third parties. While such material is published with the necessary permission none of Westpac or its related entities accepts any responsibility for the accuracy or completeness of any such material. Although we have made every effort to ensure this information is free from error, none of Westpac or its related entities warrants the accuracy, adequacy or completeness of this information, or otherwise endorses it in any way. Except where contrary to law, Westpac Group intend by this notice to exclude liability for this information. This information is subject to change without notice and none of Westpac or its related entities is under any obligation to update this information or correct any inaccuracy which may become apparent at a later date. This information may contain or incorporate by reference forward-looking statements. The words “believe”, “anticipate”, “expect”, “intend”, “plan”, “predict”, “continue”, “assume”, “positioned”, “may”, “will”, “should”, “shall”, “risk” and other similar expressions that are predictions of or indicate future events and future trends identify forward-looking statements. These forward-looking statements include all matters that are not historical facts. Past performance is not a reliable indicator of future performance, nor are forecasts of future performance. Whilst every effort has been taken to ensure that the assumptions on which any forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The ultimate outcomes may differ substantially from any forecasts.
Conflicts of Interest: In the normal course of offering banking products and services to its clients, the Westpac Group may act in several capacities (including issuer, market maker, underwriter, distributor, swap counterparty and calculation agent) simultaneously with respect to a financial instrument, giving rise to potential conflicts of interest which may impact the performance of a financial instrument. The Westpac Group may at any time transact or hold a position (including hedging and trading positions) for its own account or the account of a client in any financial instrument which may impact the performance of that financial instrument.
Author(s) disclaimer and declaration: The author(s) confirms that no part of his/her compensation was, is, or will be, directly or indirectly, related to any views or (if applicable) recommendations expressed in this material. The author(s) also confirms that this material accurately reflects his/her personal views about the financial products, companies or issuers (if applicable) and is based on sources reasonably believed to be reliable and accurate.
Further important information regarding sustainability-related content: This material may contain statements relating to environmental, social and governance (ESG) topics. These are subject to known and unknown risks, and there are significant uncertainties, limitations, risks and assumptions in the metrics, modelling, data, scenarios, reporting and analysis on which the statements rely. In particular, these areas are rapidly evolving and maturing, and there are variations in approaches and common standards and practice, as well as uncertainty around future related policy and legislation. Some material may include information derived from publicly available sources that have not been independently verified. No representation or warranty is made as to the accuracy, completeness or reliability of the information. There is a risk that the analysis, estimates, judgements, assumptions, views, models, scenarios or projections used may turn out to be incorrect. These risks may cause actual outcomes to differ materially from those expressed or implied. The ESG-related statements in this material do not constitute advice, nor are they guarantees or predictions of future performance, and Westpac gives no representation, warranty or assurance (including as to the quality, accuracy or completeness of the statements). You should seek your own independent advice.
Additional country disclosures:
Australia: Westpac holds an Australian Financial Services Licence (No. 233714). You can access Westpac’s Financial Services Guide here or request a copy from your Westpac point of contact. To the extent that this information contains any general advice, it has been prepared without taking into account your objectives, financial situation or needs and before acting on it you should consider the appropriateness of the advice.
New Zealand: In New Zealand, Westpac Institutional Bank refers to the brand under which products and services are provided by either Westpac (NZ division) or Westpac New Zealand Limited (company number 1763882), the New Zealand incorporated subsidiary of Westpac ("WNZL"). Any product or service made available by WNZL does not represent an offer from Westpac or any of its subsidiaries (other than WNZL). Neither Westpac nor its other subsidiaries guarantee or otherwise support the performance of WNZL in respect of any such product. WNZL is not an authorised deposit-taking institution for the purposes of Australian prudential standards. The current disclosure statements for the New Zealand branch of Westpac and WNZL can be obtained at the internet address www.westpac.co.nz .
Singapore: This material has been prepared and issued for distribution in Singapore to institutional investors, accredited investors and expert investors (as defined in the applicable Singapore laws and regulations) only. Recipients of this material in Singapore should contact Westpac Singapore Branch in respect of any matters arising from, or in connection with, this material. Westpac Singapore Branch holds a wholesale banking licence and is subject to supervision by the Monetary Authority of Singapore.
U.S.: Westpac operates in the United States of America as a federally licensed branch, regulated by the Office of the Comptroller of the Currency. Westpac is also registered with the US Commodity Futures Trading Commission (“CFTC”) as a Swap Dealer, but is neither registered as, or affiliated with, a Futures Commission Merchant registered with the US CFTC. The services and products referenced above are not insured by the Federal Deposit Insurance Corporation (“FDIC”). Westpac Capital Markets, LLC (‘WCM’), a wholly-owned subsidiary of Westpac, is a broker-dealer registered under the U.S. Securities Exchange Act of 1934 (‘the Exchange Act’) and member of the Financial Industry Regulatory Authority (‘FINRA’). This communication is provided for distribution to U.S. institutional investors in reliance on the exemption from registration provided by Rule 15a-6 under the Exchange Act and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors in the United States. WCM is the U.S. distributor of this communication and accepts responsibility for the contents of this communication. Transactions by U.S. customers of any securities referenced herein should be effected through WCM. All disclaimers set out with respect to Westpac apply equally to WCM. If you would like to speak to someone regarding any security mentioned herein, please contact WCM on +1 212 389 1269. Investing in any non-U.S. securities or related financial instruments mentioned in this communication may present certain risks. The securities of non-U.S. issuers may not be registered with, or be subject to the regulations of, the SEC in the United States. Information on such non-U.S. securities or related financial instruments may be limited. Non-U.S. companies may not be subject to audit and reporting standards and regulatory requirements comparable to those in effect in the United States. The value of any investment or income from any securities or related derivative instruments denominated in a currency other than U.S. dollars is subject to exchange rate fluctuations that may have a positive or adverse effect on the value of or income from such securities or related derivative instruments.
The author of this communication is employed by Westpac and is not registered or qualified as a research analyst, representative, or associated person of WCM or any other U.S. broker-dealer under the rules of FINRA, any other U.S. self-regulatory organisation, or the laws, rules or regulations of any State. Unless otherwise specifically stated, the views expressed herein are solely those of the author and may differ from the information, views or analysis expressed by Westpac and/or its affiliates.
UK and EU: The London branch of Westpac is authorised in the United Kingdom by the Prudential Regulation Authority (PRA) and is subject to regulation by the Financial Conduct Authority (FCA) and limited regulation by the PRA (Financial Services Register number: 124586). The London branch of Westpac is registered at Companies House as a branch established in the United Kingdom (Branch No. BR000106). Details about the extent of the regulation of Westpac’s London branch by the PRA are available from us on request.
Westpac Europe GmbH (“WEG”) is authorised in Germany by the Federal Financial Supervision Authority (‘BaFin’) and subject to its regulation. WEG’s supervisory authorities are BaFin and the German Federal Bank (‘Deutsche Bundesbank’). WEG is registered with the commercial register (‘Handelsregister’) of the local court of Frankfurt am Main under registration number HRB 118483. In accordance with APRA’s Prudential Standard 222 ‘Association with Related Entities’, Westpac does not stand behind WEG other than as provided for in certain legal agreements (a risk transfer, sub-participation and collateral agreement) between Westpac and WEG and obligations of WEG do not represent liabilities of Westpac.
This communication is not intended for distribution to, or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation. This communication is not being made to or distributed to, and must not be passed on to, the general public in the United Kingdom. Rather, this communication is being made only to and is directed at (a) those persons falling within the definition of Investment Professionals (set out in Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (the “Order”)); (b) those persons falling within the definition of high net worth companies, unincorporated associations etc. (set out in Article 49(2)of the Order; (c) other persons to whom it may lawfully be communicated in accordance with the Order or (d) any persons to whom it may otherwise lawfully be made (all such persons together being referred to as “relevant persons”). Any person who is not a relevant person should not act or rely on this communication or any of its contents. In the same way, the information contained in this communication is intended for “eligible counterparties” and “professional clients” as defined by the rules of the Financial Conduct Authority and is not intended for “retail clients”. Westpac expressly prohibits you from passing on the information in this communication to any third party.
This communication contains general commentary, research, and market colour. The communication does not constitute investment advice. The material may contain an ‘investment recommendation’ and/or ‘information recommending or suggesting an investment’, both as defined in Regulation (EU) No 596/2014 (including as applicable in the United Kingdom) (“MAR”). In accordance with the relevant provisions of MAR, reasonable care has been taken to ensure that the material has been objectively presented and that interests or conflicts of interest of the sender concerning the financial instruments to which that information relates have been disclosed.
Investment recommendations must be read alongside the specific disclosure which accompanies them and the general disclosure which can be found here. Such disclosure fulfils certain additional information requirements of MAR and associated delegated legislation and by accepting this communication you acknowledge that you are aware of the existence of such additional disclosure and its contents.
To the extent this communication comprises an investment recommendation it is classified as non-independent research. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and therefore constitutes a marketing communication. Further, this communication is not subject to any prohibition on dealing ahead of the dissemination of investment research.