The Board Minutes set out the options for the February call on QE; highlight the differences between Australia and US/UK; and a detailed background behind the Board’s current thinking on wages.
The points of interest in the Minutes of the December RBA Board meeting covered three issues: detailed analysis of the case for the QE decision in February; some insights, including from the Bank’s own liaison work, into prospects for wages growth; and a comparison between Australia and other countries with respect to wages and inflation.
The decisions on the timing of the first rate hike will hinge on those developments.
Two main differences between Australia and those countries experiencing high inflation at the moment stood out. Firstly, Australia had not experienced sharp increases in electricity or gas prices. But most importantly “In economies where participation had been slow to recover and case numbers in the pandemic had been high, such as the United States and United Kingdom, nominal wages growth was running at its fastest pace for years. However, similar to the Australian experience, nominal wages growth had remained subdued in the euro area and in Canada.”
Still, Westpac believes that the RBA’s current forecast of 2.25% for underlying inflation in 2022 is too low – we are currently at 2.8%.
However, the fate of rate policy will be highly dependent on wages growth in 2022. The Governor has indicated on a number of occasions that he would look through higher inflation as not being sustainable unless wages growth was printing 3%. His ideal steady state configuration would be 2.5% inflation; 4% wages growth, supported by 1.5% productivity growth.
The Minutes provide considerable insights into the factors behind the Bank’s thinking on wages. It was noted that “firms in the Bank’s liaison program continued to report difficulties finding workers for certain roles, including in construction, professional services, agriculture, and hospitality sectors”.
These shortages line up closely with the impact of the closed borders where skilled workers (professionals and construction); “back packers” (agriculture; hospitality; construction) and foreign students (hospitality and professionals) are all critical to those sectors.
The Minutes also noted that more workers felt encouraged by strong labour market conditions to change jobs – but on a micro basis only the highly skilled professionals showed a marked increase whereas “mobility rates in other sectors had remained in line with historical averages”- that was in stark contrast with the US where resignation rates across the spectrum were at historically high levels.
While wages growth had lifted in the September quarter it was only back to pre-pandemic levels, with only professional services back to 3%. Individual agreements showed faster increases but, as the Governor pointed out in a recent speech, there is likely to be considerable inertia in enterprise agreements (2- 3 years in duration) and the minimum wage setting which occurs annually. These two categories cover more than 50% of workers.
Surprisingly the Bank’s liaison program suggested that firms were generally expecting wage increases over the coming year of around 2.5%, which is broadly in line with their assessments of unions’ expectations.
Understandably the outlook is conditional on the impact of the Omicron variant. Although as with the Bank’s assessment of Delta some months ago it is “a new source of uncertainty, but was not expected to derail the recovery.”
Last week, in his final speech for the year, the Governor outlined the details of a discussion at the Board meeting about the decision on the Quantitative Easing program that will be made at the February 1 Board meeting.
The Minutes outline the same details.
Three options were discussed: to taper in February and cease purchases in May; to taper in February and review in May; to cease purchases altogether in mid-February.
The three conditions – the actions of other central banks; the functioning of the Australian bond market; and progress towards the goals of full employment and inflation would be relevant.
The Minutes noted that the forecasts in November were consistent with the first option.
It has been Westpac’s forecast that the Bank would adopt the first option but the Governor points out that if the revised forecasts at the February meeting show more progress than expected in November the Board would be prepared to cease the program altogether.
The key forecasts in November were: underlying inflation to print 2.25% in 2022; wages growth at 2.5%; and the unemployment rate at 4.25% by end 2022.
We expect that the December quarter underlying inflation rate will print 0.6% pushing the annual rate to 2.3%, compared to the November forecast of 2.25%. That might be sufficient to push the 2022 forecast to 2.5% (forecasts are always calibrated in 0.25% increments), given that the 6 month annualised rate would be 2.6%.
The unemployment rate is currently 4.6% to November which is below the forecast in November of 4.75%, so there is a possibility that the February forecast for end 2022 might be reduced from 4.25% to 4.0%, the December employment report which will print on January 20th will be important here. Given that it fell sharply in November from 5.2% in October there may be room for a statistical correction pushing the rate to move into line with the November forecast.
It seems unlikely, given the discussion at the December Board around wages, that the 2.5% forecast for wages growth would be adjusted.
But the uncertainty around the impact of Omicron over the next six weeks warrants caution with respect to that February decision.
At this stage we remain comfortable with our long standing option 1 forecast.
We do accept, however, that whereas it was reasonable to anticipate that the Board would take a steady approach to QE, in line with the Bank of Canada that scaled from $4 billion to $2 billion earlier in the year and Chair Powell’s response in the Q and A session when he noted the FED’s previous experience with a sudden large tapering to justify the recently announced staged taper the Governor’s bold promotion of option 3 signals that the Board is not concerned with any impact of a sudden cessation of purchases on the market.
Finally, as we saw with the Governor’s Statement following the December meeting, no date was used for the timing when conditions for a rate hike will be achieved compared with “end 2023” in November and “2024” in previous minutes. At least we did not see the “not next year” that figured in the Governor’s recent speech, although the progression of the rhetoric is fairly clear.
Conclusion:
The Minutes provide useful insights into the Bank’s assessment of the outlook for wages growth while providing more detail on the differences between Australia and the US/UK.
They provide appropriate respect for the uncertainty around Omicron although use the Delta rhetoric of “will not derail the recovery”.
While markets and commentators have shown more than usual volatility around the forecasts, Westpac has stuck with its “February 2023” date for the first hike in this cycle which we released as far back as June 18.
We continue to monitor developments with the key issues being Omicron; the sustainability of the current inflation surge; and the inertia of wages growth.
In the near term these issues will also determine the Bank’s approach to its QE decision in February, where option 1 remains our call.
