The RBA still wants reassurance
The RBA Board held rates steady today, as expected by almost everyone. It is still not ruling out a hike, but nor is it ruling out a cut once it achieves sufficient confidence that inflation will return to the 2–3% target range sustainably.
The RBA Board held rates steady today, as expected by almost everyone. While the policy decision was well anticipated, it was something of a shift from the RBA’s own views from three months ago. In the most recent statement the Board stated, “The path of interest rates that will best ensure that inflation returns to target in a reasonable timeframe will depend upon the data and the evolving assessment of risks, and a further increase in interest rates cannot be ruled out.” This is noticeably softer language than the media release in December, which read, “Whether further tightening of monetary policy is required to ensure that inflation returns to target in a reasonable timeframe will depend upon the data and the evolving assessment of risks.” But it is still a little on the hawkish side relative to most expectations; the Board were not about to do a complete 180-degree turn in the space of three months. That said, in the subsequent media conference, Governor Bullock stated that the Board were “not ruling anything in or out”.
Inflation is still characterised as high. Although goods price inflation has declined faster than forecast, the media release and SMP emphasise that services inflation remains high and is only declining at the previously forecast pace. That said, the upgrade to the inflation forecast for calendar 2025 in the November forecast round has been taken back. Trimmed mean inflation is now expected to be 2.8% over calendar 2025, closer to the forecast from the August SMP round.
Since the last Board meeting in December, essentially all the domestic data have been weaker than assumed in the RBA’s November forecast round. Consumer spending, investment and especially inflation all ended 2023 weaker than the RBA forecast. The narrative that inflation had become increasingly home-grown and demand-driven has become harder to sustain.
The RBA is still of the view that the level of demand is too strong, even if the rate of growth “remains subdued”. It characterises demand and supply as “moving towards a better balance” and credits higher interest rates as working to establish that better balance. It also believes that the labour market is too tight, if only in “pockets”, as Governor Bullock said in the media conference. Some of the language about domestic demand in the SMP has nonetheless softened. The information from liaison suggested that firms are finding it increasingly difficult to pass on cost increases.
In line with this softer data, the forecasts for consumption were reduced. The recovery in dwelling investment has also been pushed out. GDP growth is forecast to be lower across the whole horizon than in the November round, and unemployment higher. The SMP also pointed to indicators of a broader moderation in wages growth in the period ahead.
The Statement on Monetary Policy (SMP) contains a new section showing an assessment of spare capacity, which shows estimates of labour market and output indicators being above capacity. Much of this is based on internal models that have not been published, though some are external estimates attributed to organisations such as the OECD. Given the current state of the academic literature, it is doubtful that these models adequately allow for the possibility that supply capacity could bounce back as the ripple effects from the pandemic and other shocks unwind. Also noteworthy is that this section highlights the low vacancy rates for residential real estate as evidence of demand exceeding supply, but the text does not mention the above-average vacancy rates in commercial real estate. If inflation outcomes continue to surprise the RBA on the downside, this assessment would need to be – and would be – revised.
As stated previously, we do not expect any further rate increases by the RBA this cycle. Rate cuts are still some way off, though. The RBA Board will need to be sufficiently comfortable that inflation will definitely decline into the 2–3% target band. It will also want to be confident in the recovery in productivity. We continue to expect the RBA to reach this level of comfort around September.
We doubt that the Board are even thinking about thinking about rate cuts yet, though. In a slight departure from the language in the media release, the Governor stated that the Board are “not ruling anything in or out”. Both a hike and a cut could be contemplated if the data pointed to it being necessary. She also emphasised that they do not need to see inflation actually inside the band, let alone at the midpoint of 2½%, to cut rates. But they do need to be confident that once it gets there, it will stay there.
Today ushered in many of the new arrangements recommended by the RBA Review, including the simultaneous release of the Statement on Monetary Policy. (This rescheduling had previously been contemplated by the staff, as revealed in the Third Request for Information bundle on the RBA Review web site. It was evidently only feasible with the advent of the longer Board meetings.) Some of the recommended changes, including unattributed votes and public appearances by Board members, will not come into effect until the enabling legislation is passed and the Monetary Policy Board formed, later in the year.
The shorter, more formatted SMP document also contains additional detail about the forecasts, including additional variables and an assessment of how the current state of the economy compares with the RBA’s view of full employment. In particular, the implied path for productivity was shown for the first time. This shows the assumed solid bounce-back and reversion to a trend a little above 1% annual growth. It was pleasing to see the RBA’s recognition in the text of the SMP that some of the weakness in productivity occurred because hours worked jumped too fast for the capital stock to keep up, and that this will unwind over time. This is in line with the analysis of Westpac Economics colleagues Pat Bustamante and Jameson Coombs last year.
Over the period ahead, the RBA Board will be focused on the data flow. It will “continue to pay close attention to developments in the global economy, trends in domestic demand, and the outlook for inflation and the labour market.” It will also be watching for signs that medium-term inflation expectations dislodge from their currently well-anchored state.
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