The Reserve Bank Board has lifted its growth forecast in 2021 to well above Consensus while lowering its unemployment forecast by end 2021 to 5%. There has been a slight upward revision to the inflation outlook. Policy changes will now be considered at the July Board meeting.
As expected, the Reserve Bank Board decided to maintain its policy settings at its May meeting.
However, the Governor did announce that the Term Funding Facility which expires in June will not be extended.
He also announced that the decisions on the extension of the Yield Curve Control (YCC) policy from the April 2024 bond to the November 2024 bond and the next stage of its Quantitative Easing program will be considered at the July Board meeting.
Westpac, which expects the extension of the YCC and the adoption of another $100 billion QE program, had anticipated those decisions in August.
It is somewhat surprising to choose July given that the decisions could have been partly based on the revised forecasts that will be released after the August Board meeting, and, most importantly would cover forecasts out to the end of 2023.
On Friday, May 7, the Bank will release its revised forecasts in the May Statement on Monetary Policy. The forecasts, like those in February, will be out to mid 2023.
As has been the case in the past, the key forecast revisions were revealed in today’s Statement from the Governor.
The forecasts show a significant lift in the Bank’s assessment of the economy.
The growth rate in 2021 has been lifted from 3.5% (in February) to 4.75%. That is a larger than expected increase and compares with Westpac’s above Consensus forecast of 4.5%. The growth forecast for 2022 is unchanged at 3.5% (compared to Westpac’s forecast of 3.0%).
The unemployment forecasts were always going to be reduced substantially given that the forecasts in February were before we saw the fall in the unemployment rate in February and March from 6.3% to 5.6% along with the associated very strong partial indicators including job vacancies.
These partials in particular have probably tempered any concerns the Bank had about disruption to the labour market in the wake of the expiration of the JobKeeper program in March.
The unemployment forecast for end 2021 has been reduced from 6% to 5% ( Westpac’s forecast) and the forecast for 2022 has been reduced from 5.5% to 4.5%.
It is also relevant that the words in the April Statement, “the economy is operating with considerable spare capacity and unemployment is still too high”. have been dropped from the May Statement.
The inflation forecasts have also been revised. Even though the March Inflation Report printed a “low” 0.3% for the Trimmed Mean the Bank’s forecast in February had the trimmed mean increasing by around 0.6 ppt’s over the first half of 2021 indicating that the 0.3% was in line with expectations at that time.
However, with the lift in growth and a lower unemployment profile the underlying inflation forecasts have been increased from 1.25% to 1.5% for 2021 and from 1.75% to 2.0% for mid 2023.
With these more optimistic forecasts the “test” was whether the Governor would still maintain that the conditions necessary to increase the cash rate would be unlikely “until 2024 at the earliest”.
That phrase is certainly repeated in the May Statement by the Governor but whereas in February; March; and April the Statement was always the same “the Board does not expect these conditions to be met until 2024 at the earliest” this time it is simply “This is unlikely to be until 2024 at the earliest”.
It would be “over interpreting” to conclude that it is now the opinion of the Governor but not the Board but somewhat strange that the consistent wording would be changed. The Bank knows how markets “agonise” over every word, particularly in the final paragraph.
For my part I am not inclined to read anything into it. There are plenty of times that the words in in the Governor’s statement change for quite innocuous reasons.
And despite the lower trajectory for the unemployment rate we think the Bank has lowered its estimate of full employment from 4.5% to around 4%.
To generate the 3%+ wages growth the unemployment rate will need to be holding at or below full employment rate for some time.
On current projections the forecasts might have the unemployment rate at 4% by end 2023.
That rate would need to hold through 2024 to generate the necessary wages and inflation results by the end of 2024.
The growth / inflation/ unemployment issues are the keys to the policy outlook.
The commentary around other issues – the AUD and housing is unchanged from April – “The Australian dollar remains in the upper end of the range of recent years” and “housing markets have strengthened … it is important that lending standards are maintained.”
Conclusion
While we expected the Bank to revise its forecasts for the unemployment track the revisions are slightly more optimistic than we had expected.
In turn that fed into a substantial lift in the 2021 growth forecast to well above Consensus (AFR April 6 survey Consensus was 3.8% when Westpac was at 4.5%) and a modest 0.25% lift in the inflation forecasts.
It will now be interesting to see in the May SOMP on May 7 the size of the revision to wages growth (mid 2023) which is currently 2%.
Even if it is lifted to 2.5% in the SOMP on Friday it will still be difficult to see wages growth at 3% + through 2024 supporting the view that the conditions for a rate increase will not be met “until 2024 at the earliest”.
As noted above Westpac confirms that it expects an extension of YCC and a new $100 billion QE program to be announced at the July Board meeting.
