The RBA has lifted its forecasts for growth; labour market; and inflation/wages. However these forecasts are based on faster than expected recovery but not a sustained boost with the progress towards targeted conditions expected to be mediocre. Under those circumstances the best policy approach is to continue with the current approach of targeting a 3 year bond (November 2024) and extending another $100 billion tranche of QE.
The RBA’s May Statement on Monetary Policy contains significant changes to the forecast economic outlook.
Most of these changes were signalled by the Governor in his Statement following the Board meeting on May 4.
Economic Growth
GDP growth forecast for 2021 has been lifted from 3.5% to 4.75%. That forecast is now in line with the Westpac forecast of 4.5% and well above Consensus of 3.8% (AFR Survey, April 6). That “burst” of growth is forecast to slow back to 3.5% (unchanged from February), also in line with the Westpac “3%” view; and to 3% (unchanged) in the year to June 2023 (end point of forecast period).
The main driver of the boost to growth in 2021 is the consumer, with consumption growth lifted from 4% to 5.5% (Westpac 5.8%) reflecting faster growth in disposable income and a fall in the household savings rate from 12% to 8% over the year.
Business investment and dwelling investment growth rates have been upgraded, particularly as government cash and tax subsidies have lifted momentum. However, these improvements are largely concentrated in 2021 with the profiles in the latter part of the forecast period also largely unchanged.
The Labour Market
The forecast unemployment rate by end 2021 has been reduced from 6% to 5% although the expected further improvement in the unemployment rate slows in the revised forecasts.
In February it was expected that the unemployment rate would fall 0.75 ppt’s to 5.25% by mid 2023 while the revised forecasts have the fall of only 0.5 ppt’s to mid 2023, including no expected improvement in the first half of 2023 (remaining at 4.5% from end 2022).
That stalling of the pace of improvement is consistent with the forecast for employment growth which lifts from 3% to 5.75% in 2021 but holds at the same pace of 1.25% in 2022 and even slows somewhat to mid 2023 from 1.25% to 1.0%.
This profile is consistent with the theme that the momentum in the economy and the labour market which is currently reflecting the rapid reopening and the immediate impact of the various support packages (which have now been unwound) will ease substantially in future years making the RBA’s task of achieving its target conditions quite challenging.
Wages and Prices
The forecast pace of wages growth has been lifted somewhat by 0.25% in 2021, from 1.5% to 1.75%, reflecting the faster progress in bringing down the unemployment rate but this improvement in the pace of wage inflation is forecast to ease over the remainder of the forecast period to 0.5 ppt’s (same as in February) rising to 2.25% by end 2022 but holding steady at 2.25% over the first half of 2023.
The pattern is the same with the trimmed mean inflation forecast – the 2021 pace is lifted from 1.25% to 1.5% but the 0.5% increase in the pace out to mid 2023 is steady at 0.5 ppt’s reaching 2% rather than 1.75% in the February forecasts.
My conclusion from the changes the RBA has made to its forecasts is that it has recognised a faster than expected bounce back in 2021 but anticipates that the observed boost in the pace of recovery in later years will be followed by a “slow grind” in inflation; wages and employment.
Under that interpretation it still seems likely that the RBA is doubting whether it will achieve its objectives around inflation; wages; and full employment in 2024.
And that analysis is entirely consistent with a literal interpretation of the Governor’s conclusion “This is unlikely to be until 2024 at the earliest”.
It is true that the market made something of the change in the wording from the February; March; and April “The Board does not expect these conditions to be met by 2024 at the earliest” but, based on the full set of forecasts in the May SOMP, the new wording does not look to be a game changer.
For me, the most significant insights in these revised forecasts is the Bank’s reluctance to read a stronger profile into the wages outlook given the rapid fall in the unemployment rate.
Certainly the Bank’s liaison is not signalling a strong response from employers to some emerging labour shortages.” Wage freezes remain fairly widespread across industries with over a quarter of firms in the Bank’s business liaison program reporting that a freeze was in place in April …. Although fewer firms are expecting to have wage freezes in place in coming months”.
The Bank liaison survey currently reports 20 year lows in the proportion of firms reporting wages growth above 2%.
Understandably, at such a critical inflexion point, the Bank has, conducted two scenarios – one upside; one downside.
For the upside, GDP growth is lifted to 6% in 2021 and 4.5% in 2022, while the unemployment rate falls to 4.5% by end 2021 and 3.75% by mid 2023 (a faster improvement after 2021 than the baseline); trimmed mean inflation rises to 2.25% and wages growth reaches 2.75% Â by mid 2023 (estimate from the graph 5.11).
Even on this upside scenario wages growth is still unlikely to reach 3%+ by the beginning of 2024 although the case for the trimmed mean reaching 2.5% by the beginning of 2024 could certainly be made.
Due to the sluggishness of wages even under that upside scenario a rate hike in the first half of 2024 should be questionable.
(The dynamics at issue are how long the economy needs to hold below full employment to generate adequate wages pressure).
What do these forecasts and scenarios tell us about the policy decisions which are going to be made at the July Board meeting?
The baseline forecasts would not give the Board sufficient comfort that the economy is set to achieve the conditions consistent with full employment (we think the Bank sees that as 4%); inflation sustainably within the 2 to 3 per cent target range; and wages growth “materially higher than it is currently” (the Governor has spoken about 3%+ on various occasions) during 2024.
That is particularly significant given the consistent theme in the baseline forecast that the pace of improvement in the economy beyond 2021 will be very modest.
Over the next two months it is going to be difficult for the Board to get sufficient evidence to challenge the baseline forecasts. There will be one read of GDP for the first quarter (note the 6% GDP growth forecast for the Upside scenario); one print of the Wage Price Index; two retail sales reports; and two employment reports.
Markets will be most focussed on the employment reports. Very strong employment reports might encourage the Board to believe the 4.5% “upside” unemployment rate condition by end 2021 but the Risk/Reward should not be attractive to the Board.
Backing off on extending the maturity of the bond rate targeting process and slowing or even curtailing bond purchases (stopping QE) should only be followed if the Board was convinced that the upside scenario was central and even had upside risks.
At this stage, given the lack of conviction in the baseline forecasts, particularly around wages, that the appropriate conditions will be achieved in 2024 it would be prudent for the Board to continue down the current policy path of announcing a new tranche of QE purchases of a further $100 billion and extending the bond targeting from the April 2024 bonds to the November 2024.
