We confirm the view we have held since June 18 that the first rate increase from the RBA will be the February Board meeting in 2023. Markets continue to run ahead of the RBA’s likely timing where the policy approach has changed to favour patience.
Following the September quarter Inflation Report we confirm our forecast that the first rate hike (15 basis points) by the RBA will be in the March quarter, 2023, with the February 1 Board meeting being the most likely timing.
Last week I wrote, “Markets are right to challenge RBA guidance, but have now gone too far”.
At that point market pricing indicated the likelihood of two 25 basis point rate hikes to November next year with one priced in by August.
Prospects for our favoured first hike – 15 basis points to return the cash rate to 0.25% were priced in for as early as June.
All of this was going to be impacted by the Inflation Report for the September quarter that was to print on October 28.
We expected a headline inflation print of 0.8% and a core (Trimmed Mean) print of 0.5%.
Because the RBA will formulate its policy around the Trimmed Mean we expected that a “0.5%” print would cause the market to reset.
In the event the headline did print 0.8% but the Trimmed Mean printed 0.7%, an exciting development for the market.
Subsequent repricing in the market now has three 0.25% rate hikes by November; two hikes by August; with the first 0.25% hike coming in June; while, if the RBA favours the first move to be 0.15%, then it is expected in May.
When I wrote last Friday our forecasts entailed annual Trimmed Mean printing 2.8% by end 2022; and 2.5% by end June 2022.
As we have consistently emphasised, this expected lift in inflation reflected, in the first stage, the “collision” of strong demand growth, with supply constrained goods and labour markets. Those pressures will be most intense around the construction of new dwellings.
As we move through 2022 the source of the inflation pulse is likely to pivot from supply constraints to rising wages growth as the unemployment rate falls below 4% by year’s end. Wage pressures are the most reliable sign that inflation pressures will be sustained underpinning our forecast two year tightening cycle where we expect the cash rate to peak at 1.25% by end 2024.
That forecast assumed the following quarterly profile: 0.5% (September); 0.7% (December); 0.6% (March); 0.6% (June); 0.8% (September); and 0.7% (December) for growth in the Trimmed Mean.
So, the lift to 0.7% in the quarterly print for September has come a quarter earlier than we had expected.
There are some anomalies in the September Report – a range of components have been imputed due to the collapse in certain spending categories in the September quarter and the house purchase component has been affected by the expiration of the Home Builder subsidies in March.
However, it does not affect our forecast for 2022 which already incorporated some of the pressures we saw in the September Report.
On our forecasts, the first rate hike in February 2023 will follow the December quarter Inflation Report that will print on January 27 2023.
That report is likely to confirm that growth in the Trimmed Mean has held above 2.5% for three consecutive quarters, ample support for the Governor’s requirement “we want to see inflation around the middle of the target range and have reasonable confidence that inflation will not fall below the 2–3 per cent target range” (14 September).
To feel confident that the lift in inflation will be sustainable the Board will need to see a marked increase in wage inflation. Under our scenario the unemployment rate falls to 3.8% by end 2022 and wages growth lifts to 2.8% in 2022 – slightly short of the Governor’s guideline of 3%.
It is very important to understand that wage increases will not be “indexed” into the inflation profile.
The era of the 1970’s when “cost of living adjustments” figured in wage arrangements and employers, confident in their pricing power, were prepared to accept higher wages are unlikely to recur.
Even though the profile of inflation could probably justify a rate increase at the November 2022, meeting waiting a few months to assess the unemployment / wage profile would seem to be prudent.
Remember that the RBA believes that, in this cycle, it is justified in being patient to ensure a sustainable result. The almost “impatient” approach now embedded in markets may be underestimating the significance of the Governor’s commitment to moving patiently- only when the objectives of inflation and full employment have been firmly achieved rather than forecast.
Markets should be more aware that the rules of policy in Australia have changed.
And of course, our forecasts stand in direct contrast with the RBA’s forecasts that TM inflation will print 1.75% for 2021 and 2022.
These forecasts should be revised for the November Statement on Monetary Policy, hopefully to 2.0% and 2.5% respectively.
But we also have the other inputs into the Monetary Policy decision – the unemployment rate and wages growth.
Westpac is forecasting that wages growth will print 2.8% for 2022, up rom the current 1.7%, while the unemployment rate will fall to 3.8% by end 2022.
The RBA’s current forecasts are 2.5% for wages growth in 2022; and an unemployment rate down to 4.25% by end 2022.
Westpac’s forecasts for wages growth and the unemployment rate are much closer to the RBA’s than they are for inflation.
We would like to see slightly faster wages growth and a lower unemployment forecast when the RBA releases its revised forecasts.
Currently the RBA’s growth forecast for 2022 is 4.25% compared to Westpac’s 7.4%.
But our 2022 forecast is based on our current assessment that the Australian economy will contract by 4% in the September quarter whereas RBA noted in early August that they expected the economy to contract by “at least 1%” in the September quarter.
A deeper contraction in the September quarter (hours worked have already been estimated by the ABS to have contracted by 3% in the September quarter) is likely to see a stronger forecast recovery pace in 2022 as the economy returns to the pre delta trajectory (RBA’s assessment in August).
That adjustment could see the growth forecast in 2022 lifted to at least 6% consistent with faster employment growth; a lower unemployment rate and stronger wages growth.
Certainly, the Employment Reports and Payroll Reports since the August SOMP have also indicated a more resilient labour market.
Wages growth around 2.75% and an unemployment rate of 4% by end 2022 would seem a reasonable adjustment to the forecasts.
If we were to see such changes in the Bank’s forecasts in the November Statement on Monetary Policy the issue arises as to whether the Governor would be prepared to alter the guidance, “The central scenario for the economy is that this condition will not be met before 2024.”
Personally, I would strongly applaud acceptance that the Governor now expects that the conditions necessary to begin the move away from the emergency policy settings will be achieved earlier than previously expected.
The strong existing guidance, particularly during 2020, was key to underpinning confidence in the RBA’s commitment to doing everything reasonably within its powers to protect the Australian economy.
Success is now likely to come earlier than expected and a cautious recognition of that prospect would be welcome.
