The Reserve Bank Board today lifted the cash rate by a further 50 basis points. The Bank has increased its inflation forecasts and lowered its growth forecasts. A significant theme is around the current momentum in the economy. That clearly points to another 50 basis points in September after which the Board can slow the pace while and still have reasonable prospects inflation returns to the target band.
The Reserve Bank Board decided to increase the cash rate by 50 basis points to 1.85% at its August Board meeting.
In his Statement, the Governor noted that the Bank has made some significant changes to their forecasts.
The headline inflation rate is now forecast to reach 7.75% by end 2022 (up from 5.9% in the May Statement on Monetary Policy); thereafter it is forecast to slow to 4% (up from 3.1%) by end 2023; and 3% by end 2024 (up slightly from 2.9% by mid 2024).
The growth forecasts have also been revised with 2022 being lowered from 4.25% in the May statement on Monetary Policy to 3.25%; with the 2023 and 2024 forecasts being lowered from 2% to 1.75%.
Note that the forecasts have been extended from June 2024 to December 2024.
The Statement continues to note that “the Board expects to take further steps in the process of normalising monetary conditions over months ahead but is not on a preset path.” That compares with the Statement in July “The Board expects to take further steps in the process of normalising monetary conditions in Australia over the months ahead.” The “not on a pre set path” comment has been used in extensive communications by the Governor on other occasions and it does not seem to be significant that it has been added to the Statement ¬– certainly not that another 50 basis points in September has been ruled out.
The most important aspect of interpreting the Statement is whether there is anything to dissuade us from our view that there will be another 50 basis point increase in September.
In earlier communications that Governor has been clear that he expects that the neutral policy setting is around 2.5%. After this decision the cash rate at 1.85% is still well short of that neutral level.
The language in the Statement could have implied that there was some uncertainty about “neutral” by downgrading the momentum of the economy.
But the Governor remains upbeat about current economic conditions; “widespread upward pressures from strong demand“ compared to “strong demand contributing to the upward pressure on prices” (in July); “the Australian economy is expected to grow strongly this year”; “national income is being boosted by a rise in the terms of trade , which are at a record high”; “consumer spending has been resilient and an upswing in business investment is underway.”
Even the downward revision to GDP growth in 2022 can be partly attributed to the likely 0.5% “ miss” on the GDP growth forecast in the March quarter which was not known when the May SOMP predicted growth of 4.25% in 2022.However, like the Treasury, there seems to be a very cautious assessment of the growth rate in the June quarter (possibly 1.3% compared to Treasury of 0.9% (our estimate) and our own forecast of at least 2%).
But that 1.3% is still comfortably more than double trend.
The Bank is also predicting a very modest weakening in the labour market in 2023/24 with the unemployment rate only lifting to 4% by end 2024 compared to our forecast of 5%.
So, there does not appear to be grounds for assessing that the Board will slow the pace at the September meeting – a further 0.5% is very likely.
But the cash rate will then reach 2.35% – within the “neutral zone” from the RBA’s perspective.
It is then that some of the cautious aspects of today’s Statement can be used as a signal that the Board’s preference will be to slow the pace of tightening. We expect that the Board can then move back to a “25 basis point” pace. Just as the Chairman of the Federal Reserve signalled a likely reassessment of the 75 basis point pace, at the Press Conference, at the next FOMC then the Governor’s Statement in September can do the same, although the slowdown evidence for the US economy is much clearer than for Australia – for now.
The two most cautious aspects of the August Statement are referring to the challenge of achieving the inflation target while “keeping the economy on an even keel” (a new addition) and lifting the inflation forecast for 2022 from 3.1% to 4%. That implies that the Board feels that it has more time to reach the target given the higher starting point. It may also be with an eye to the Bank’s previous poor record on forecasting inflation, believing that increasing the starting point from 5.9% to 7.75%, would require a solid lift in the 2023 forecast as well.
A test will be whether medium term inflationary expectations take a lift in the face of a less committed forecast from the RBA.
Recall that complacency around containing inflationary expectations is a trap that the Board should avoid at all costs.
Because its only measure on medium term inflationary expectations appears to be break even yields in the financial markets the Board is running a risk by signalling such patience in the face of the widespread pressures on inflation that it has described.
It is our view that the Board will have to slow the economy in 2023 (to 1% growth rate) in order to maintain a grip on inflationary expectations.
Conclusion
The 50 basis point move today was widely expected, although some analysts had been flirting with 75 basis points.
The most important aspect of the Statement was whether there was any indication that the Board might ease back to a 25 basis point pace in September. But there does not appear to be any evidence to suggest such a policy and we confirm our view that there will be another lift of 50 basis points in September.
However, there were references that might imply a more cautious approach after September and we see them as consistent with our view.
As indicated in the final sentence” the Board confirms its commitment to doing what is necessary to ensure inflation in Australia returns to target over time.”
We expect that objective will require a series of four 25 basis point moves following the 50 basis points in September.
