The Reserve Bank Board has made a sensible decision to move away from extreme policies of Yield Curve Targeting and naming the timing for the first rate hike. The Bank’s revised forecasts point to an expected first increase in 2023 but as and when circumstances evolve that view can be adjusted in the traditional way.
The Reserve Bank Board has decided to discontinue the Yield Curve Target of 10 basis points for the April 2024 Australian Government bond and has excluded the line “The central scenario for the economy is that this condition will not be met before 2024”. Of course that line referred to the Bank’s expected timing for the first increase in the cash rate.
That condition has been changed in the Statement to, “That is likely to take some time. The Board is prepared to be patient”.
We acknowledge these decisions as an appropriate response to the changing economic scenario. The adoption of a Yield Curve Target, which supported the guidance around 2024, may have been appropriate when the Australian economy was facing the emergencies of COVID but the economy has now recovered; there is evidence of rising inflation; and the growth and employment outlook is encouraging.
The time for unprecedented policy measures has passed and the Board has made an astute decision.
Westpac’s view since June 18 has been that the first-rate increase will be at the February 2023 Board meeting.
The key forecast changes which have lifted the Bank’s outlook are: core inflation is now expected to print 2.25% in 2022 (up from 1.75%) and 2.5% in 2023 (up from 2.25%).
GDP growth in 2022 is forecast at 5.5% (up from 4.25%), although this mainly reflects the downgrade of 2021 from 4% to 3%, as the Bank revises down its assessment of the contraction in the September quarter.
There is no change to the forecasts for wages growth in 2022 (still 2.5%) although, significantly, 2023 has been lifted from 2.75% to 3.0%.
The forecasts for the unemployment rate are unchanged – 4.25% in 2022 and 4% in 2023. However, the Governor does note that “one of the main uncertainties relates to the behaviour of wages at the lowest unemployment rate in decades.”
These forecasts are a little more cautious than we had expected but certainly indicate that the Board expects that the conditions necessary for the first-rate hike will be in place during 2023.
However, the Board very sensibly avoided moving the guidance to 2023 given the range of uncertainties particularly around wages and inflation.
This cautious message on the policy outlook is emphasised when the Governor compares Australia’s position with the other developed economies where rate increases appear to have been brought forward by their respective central banks.
He notes that, “Inflation pressures are also less than they are in many other countries, not least because of only modest wages growth in Australia.”
The formal explanation for discontinuing the Yield Curve Target was that “other market interest rates have moved in response to the increased likelihood of higher inflation and the effectiveness of the yield target in holding down the general structure of interest rates in Australia has diminished”.
But an equally convincing reason is that because the forecasts no longer point to 2024 as the most likely lift off date then the Target is redundant.
Overall, we still assess that the revised forecasts are too cautious. Westpac expects core inflation to print above 2.5% during the second half of 2022; the unemployment rate to reach 3.8% by end 2022; and wages growth to print 2.75%. That will be underpinned by much stronger GDP growth (7.4%) than the Bank is expecting.
Conclusion
The Board has made a responsible decision to move away from the extreme policies that served the economy well during the COVID emergencies but now the economy is recovering and inflation is lifting it is appropriate to revert back to a standard policy approach.
The implication in the Board’s forecasts that the first-rate increase is now expected to be in 2023 is interesting but dependent on the forecasts.
Westpac has stronger forecasts for growth; inflation; and the labour market which we think are consistent with an earlier first increase than implied by the Bank but we certainly agree that the market, anticipating multiple hikes in 2022, appears to have overshot.
The Governor is due to speak later today and any further insights will be signalled in a separate note.
