Key insights from the week that was.
As we anticipated, at their November meeting the RBA decided to end Yield Curve Control and remove specific date guidance on the likely timing of the first rate hike. The Bank’s revised forecasts now point to a potential first increase in the cash rate in 2023, assuming the economy performs as expected.
As detailed by Chief Economist Bill Evans, the RBA’s forecasts for growth and inflation in 2022 have been revised up; though the unemployment rate forecasts are unchanged, and the Bank remains circumspect on the prospects for wages growth, at least in 2022. Westpac are more optimistic on growth and the labour market through 2022 and consequently continue to anticipate the first RBA hike in February 2023, to be followed by additional hikes in the June and December quarters of 2023 and another two hikes in 2024 to 1.25%. Note, the RBA’s November Statement on Monetary Policy has just been released, providing full detail on the RBA’s updated forecasts and their view of the risks to the outlook. Westpac Economics’ coverage of the SoMP will be contained in our Weekly this afternoon, available on Westpac IQ.
Following a strong Q3 labour force survey, our New Zealand economics team now forecast a much more aggressive policy response by the RBNZ, with the cash rate now expected to reach 3.0% by mid-2023. This view is justified by 2.0% employment growth in the quarter, 4.2% over the past year, which has left the unemployment rate at a record low of 3.4%. Importantly, Statistics NZ estimate the lockdown bias in the unemployment rate at just 0.2%, implying a ‘true’ estimate of unemployment of 3.6% — still well below expectations and historic. While wages growth wasn’t as strong as Westpac expected, the 0.8% gain for the Labour Cost Index was still ahead of RBNZ expectations and robust. Pressure will clearly remain on wages given inflation concerns and the historically tight state of the labour market.
Further afield, data this week has been robust, but largely secondary in nature. The focus of the market has instead been on central banks, with the US Federal Reserve’s and the Bank of England’s policy committees meeting.
Showing their confidence in the economy, the US FOMC decided to start their taper immediately with a $15bn reduction in purchases in November and to lay out an unconditional schedule of further reductions to stabilise the size of their balance sheet by June 2022. However, the Committee and Chair Powell both stressed there would be no immediate follow-on for policy post the taper.
To justify rate hikes, maximum employment and inflation above 2.0%yr both have to be realised and expected to persist into the medium-term. The Committee’s forecasts and Chair Powell’s commentary both point to maximum employment being possible by end-2022, justifying our call for a December 2022 first hike. But it would take another round of inflation pressures, this time demand led, along with maximum employment to warrant an earlier move. Currently there is no clear evidence of such an outturn building.
It is also important to recognise that the FOMC wish to remain reactive not only for the first hike but the entire hiking cycle that follows. This should allow GDP growth to settle at or above trend at the end of the forecast period and warrants the possibility of additional rate hikes remaining priced into rate markets for the foreseeable future.
Turning finally to the Bank of England, though their decision to keep policy on hold in November was regarded by the market as a dovish move, it was evident in their communications that they plan “over coming months to increase Bank Rate in order to return CPI inflation sustainably to the 2% target”, “provided the incoming data, particularly on the labour market, are broadly in line with the central projections in the November Monetary Policy Report”. However, only a few rate hikes are likely over the coming year.
In the November MPR, the Bank also noted that “observing the market-implied path for Bank Rate… CPI inflation is projected to be below the 2% target at the end of the forecast period, and would probably fall a little further beyond that point, given the margin of spare capacity that is expected to emerge”. At the time of the meeting, a Bank Rate of 1.0% was priced by the market by end-2022, 75bps above its current level. From these comments and the market’s response to the decision, we can take that, while the Bank of England may act ahead of the US FOMC and other central banks, they are also likely to stop sooner.
