The Board has ceased the bond purchase program and significantly lifted its inflation forecasts but the Governor maintains the line that the sustainability of its inflation forecasts can only be achieved with much clearer evidence around wages growth. This is likely to preclude an “early” rate hike but does not dissuade us from our August call.
As expected, the Reserve Bank Governor announced that the Board has decided to cease further purchases under the bond purchase program.
The Board has decided to consider the issue of the reinvestment of the proceeds of future bond maturities at its meeting in May. Readers will be aware that the purchase program was initiated in November 2020 with maturities around the 5 to 10 year spectrum. Consequently, it will be some time before decisions will need to be made about the original bond purchase program.
On the other hand, the Governor did announce the Yield Curve Control Policy on March 19 2020 where 3 year government bonds (April 2023 maturity) were targeted – decisions on those bond maturities will be needed in early 2023.
We are always interested in the Bank’s revised forecasts and this Statement usually includes a number of key observations prior to the full list of forecasts being released on February 4.
The Bank has reduced its forecast for GDP growth in 2022 from 5.5% to 4.25% and from 2.5% to 2% in 2023.
The main source of the reduction in 2022 is likely to be the early evidence that consumer spending contracted in January due to the impact of the Omicron virus on consumers – Westpac has reduced its forecast for GDP growth in the March quarter to zero from 2.2% to reflect exactly that factor and has shaved around 1 ppt from its growth forecast for 2022.
It is also pertinent to recall that the Bank’s forecasts are based on market pricing for the cash rate. With the market forecasting a cash rate of around 2% by end 2023 (higher than in November) it is not surprising to see a growth downgrade in both 2022 and 2023.
The forecast for underlying inflation has been lifted significantly. The expected peak in coming quarters has been lifted from 2.25% (in November) to 3.25% while the forecast is that it will drift back to 2.75% by end 2023 compared to 2.5% in November.
Despite higher rates and lower growth, the forecasts for the labour market have been boosted. The unemployment rate is forecast to fall to “below 4% later in the year” reaching 3.75% at the end of 2023. That compares with 4.25% and 4% respectively in November ‘s forecasts.
The Governor’s rhetoric does not seem to be consistent with the forecasts.
He states, “While inflation has picked up, it is too early to conclude that it is sustainably within the target band.” And yet underlying inflation is currently 2.6%; is forecast by the RBA to increase to 3.25% in 2022 and still be at 2.75% by the end of 2023.”
That is inflation is forecast to hold in the upper half of the target band for at least two years!
These tactics are clearly to dissuade markets from getting too far ahead of themselves in anticipating higher rates.
Note that the has not put a date on the timing of the first move since the October meeting last year when he referred to “this condition will not be met before 2024.”
However, in speeches he maintained the “not in 2022” line as recently as December 16. The most important part of his speech tomorrow to the National Press Club will be whether he retains that” not in 2022” guidance – I would be very surprised if he chooses to do that!
The Governor gives two arguments against the sustainability of the recent inflation increase – “uncertainties about the outlook for supply side problems” and “it is likely to be some time yet before aggregate wages growth is at a rate consistent with inflation being sustainably at target.”
The choice of “aggregate” wages growth would appear to emphasise the Wage Price Index. Recall that its last three quarterly prints have been 0.6%; 0.4%; and 0.6%. The next print will be on February 23 to be followed by May 18.
To get any where near the 3% target at the next release the Index would need to print an unlikely 1.4% – that incredibly high hurdle, coupled with the Governor’s statement today should knock out any expectation of a May rate hike.
Westpac expects that the next two WPI’s will show “aggregate” wages growing at around 2.5% with a 3% 6 month annualised pace – enough, along with the sustained lift in underlying inflation, and 13 year low in the underemployment rate, to justify the August move.
Conclusion
We remain comfortable with our August call for the first move.
Predictably, the Governor has attributed the wages story as the key for the RBA concluding that their revised forecasts (which are consistent with higher rates) are still uncertain and more evidence is required before it can act.
