The minutes of the Reserve Bank’s Board meeting for February support the “patient” rhetoric of earlier communications. There is some new information on the treatment of the balance sheet although balance sheet action does not appear to be part of the expected tightening cycle. Our forecast of 3.5% for annual underlying inflation by June compared to the RBA’s 3.25% should be enough to trigger the expected first hike in August.
The Minutes of the Reserve Bank Board’s February meeting provide limited further insight into the Board’s thinking than we have already seen in previous communications from the Governor since the meeting on February 1.
These communications covered the Governor’s Statement following the February meeting; his speech to the National Press Club; and his appearance before the House of Representatives Standing Committee on Economics.
At that last hearing he somewhat lowered his guard about being “patient “(as concluded in today’s Minutes) by indicating that he would like to see two more CPI prints before he could conclude that the time was right for a rate hike. That fits into our thinking of an August hike with the two CPI reports printing on April 24 and July 24.
Our forecast for annual growth in the underlying CPI in the year to June (printing on July 24) is 3.5% (above the RBA’s forecast of 3.25%) making the case quite clear that inflation will sustainably achieve the Board’s objective of holding within the 2–3% range, even as supply pressures ease.
The theme that gave us some comfort that we did not need to see the Wage Price Index printing 3%+ before a rate hike can be expected was once again discussed in the Minutes where “the outlook for broader measures of employee earnings growth had been upgraded more substantially than base wages… bonus payments… overtime rates… job turnover… with workers more willing to change jobs at higher pay.”
The Board once again emphasises that “the pick-up in wages growth was expected to be only gradual and there was uncertainty about the behaviour of wages as the international border reopens and the unemployment rate declines to historically low levels.”
We did get some new insights into the Board’s thinking on the bond market.
The decision to cease bond purchases was explained in terms of the progress towards inflation and employment targets but also “Members noted the staff’s assessment that although the Australian bond market could accommodate further bond purchases by the Bank, there would be a rising probability of additional strains emerging.”
The Board also discussed the reinvestment program – note that no consideration is being given, at this stage, to shrinking the balance sheet through outright sales. This process of shrinking the balance sheet through not reinvesting maturing bonds is going to be a very slow process indeed.
Consider the Bank’s holdings of bonds that mature in 2022 – around $2 billion of July 2022; $2 billion of November 2022 – so virtually no inroads into the $350 billion bond holdings on the balance sheet through maturing bonds in 2022.
In 2023 it holds around $13 billion of maturing AGS; around $34 billion in 2024; and around $36 billion maturing in 2025.
Shrinking the balance sheet through not investing maturities rather than outright sales is going to be a very slow process.
This is a very different issue than is faced by the FOMC where maturities are regularly flowing while the authorities also appear to be prepared to actually shrink the balance sheet through outright sales.
Of course, the RBA assesses that the stimulatory effect on the economy is through the size of the balance sheet rather than the flow so a very large stagnant balance sheet represents an unknown dimension of stimulus that will need to be offset by traditional rate hikes.
As we move through the tightening cycle which we estimate will extend into the first quarter of 2024 with a peak terminal rate of 1.75% sheer size of the balance sheet will represent an issue for the RBA.
Our call for an August rate hike continues to be challenged by the rhetoric in the Minutes, “it was likely to be some time before aggregate wages growth would be consistent with inflation being sustainably at target” but we take considerable comfort with the consistent reference to more responsive measures of wage pressures than the Wage price Index (overtime; bonuses; turnover; business surveys).
If our forecast that annual underlying inflation reaches 3.5% by June compared with the RBA’s current forecast of 3.25% then that is likely to be sufficient to convince the Board to begin the cycle in August, particularly when prospects for any real contraction in the stimulatory but “bloated” balance sheet appear to be a long way off.
