The May Board minutes highlighted financial conditions and the data flow as key factors in the policy decisions at the July Board meeting. However the Board still supports the view that the conditions necessary to justify a rate increase are unlikely until 2024 at the earliest.
The minutes from the RBA’s May Board meeting provide some limited further insights into the all important policy decisions which are scheduled to be taken at the July Board meeting.
In the Governor’s statement following the May Board meeting he noted that “At its July meeting, the Board will consider whether to retain the April 2024 bond as the target bond for the 3 year yield target or to shift to the next maturity, the November 2024 bond. The Board is not considering a change to the target of 10 basis points. At the July meeting, the Board will also consider future bond purchases following the completion of the second of the $100 billion of purchase under the government bond purchase program in September”.
The minutes, of course, confirmed that information, but did provide some “colour” as to what would influence those decisions, “Future policy decisions would be based on close attention to the flow of economic data and conditions in financial markets in Australia”.
This guidance differs from the April minutes, “In considering this issue, members would give close attention to the flow of economic data and the outlook for inflation and employment”.
The “outlook for inflation and employment” clearly points to the Bank’s economic forecasts.
The upward revisions we saw in the May Statement on Monetary Policy still pointed to the conditions necessary to justify a rate hike being in line with the Bank’s consistent view (May minutes), “The Board viewed these conditions as unlikely until 2024 at the earliest.”
As discussed in the minutes the unemployment rate is forecast to reach 4.5% by mid-2023 – we believe that level is around 0.5% above the RBA’s assessment of full employment. Generating a sufficiently tight labour market to achieve wages growth “sustainably above 3 per cent” would require the unemployment rate to hold at the full employment level for some time – arguably through 2024.
That observation is consistent with the Bank’s forecast for wages growth by mid-2023 of only 2.25% – well short of the “above 3% “target.
It is true that the revised forecasts see the inflation rate reaching 2% by mid-2023 but, by the Bank’s own reasoning, is unlikely to hold sustainably within the 2–3% target band without much stronger wages growth than the 2.25% which is currently forecast.
We do note that the Bank’s upside scenario which is discussed in the Minutes is consistent with the policy tightening at the July meeting.
The unemployment rate is forecast to reach 3.75% by mid-2023 – below the RBA’s likely estimate of full employment and, based on eyeballing the RBA’s graph, wages growth is forecast to reach 2.75%.
For these reasons, based on the Bank’s forecasts, we expect the Board to shift the 0.1% target to the November bonds and announce a new $100 billion program for QE starting in early September.
But the minutes say that the Board will be closely watching the incoming data between now and the July meeting.
For a start it seems that there is considerable optimism that the ending of JobKeeper will not slow the momentum in the labour market. “While job losses from the end of the JobKeeper program were likely, these were expected to be more than offset by demand for labour elsewhere in the economy”.
Clearly the next two employment reports for April and May will be important. Particularly because the “upside” scenario forecasts that the unemployment rate will reach 4.5% by year’s end compared to the 5% in the baseline forecast.
But what to make of the switch to “financial conditions”?
Clearly the most obvious relevance here is the AUD – a “high” AUD tightens conditions and argues for the extension of both policies (QE in particular) to assist in easing conditions.
But the other one which is “unhelpful” for the Westpac view that the Bank will pivot to the November bond and announce a further $100 billion in QE related purchases is market pricing for the RBA cash outlook – as described in the Minutes as “the cash rate begins increasing from its current level during 2023”.
A central bank that is unable to forecast that it will achieve the necessary conditions to justify a rate hike and is confronted with a market that incorrectly (in their view) expects a much earlier achievement of the necessary conditions arguably should act to dissuade the market from such pricing by adopting a clear policy which emphasises the view.
Central banks have a record of franking market views in the near term but to “rollover” to market pricing when clearly stating a different view seems much less likely.
Which brings us to the subtle change between the Governor’s Statement and the minutes.
The all important final sentence in the minutes corrected some markets doubts about the Board’s commitment to the Bank’s forecasts.
The Governor’s Statement finished on the line “This is unlikely to be until 2024 at the earliest”; correcting the consistent line in previous communications, “The Board does not expect these conditions to be met until 2024 at the earliest.”
Some in the markets interpreted that change as indicating some uncertainty at Board level.
However, the minutes have confirmed the Board’s commitment, albeit, retaining the softer line than in April, “The Board viewed these conditions as unlikely until 2024 at the earliest.”
Conclusion
Westpac expects that a decision to tighten policy by not renewing QE and/ or not extending YCC would be inconsistent with the Bank’s guidance and its forecasts.
However, as is noted in the minutes, the data flow over the next two months may indicate a likely further significant upward revision to the forecasts.
Such a flow of data is not expected by Westpac.
