The Reserve Bank Board has abandoned its patient approach to policy and given itself sufficient flexibility to raise rates as early as June. This decision will depend on the data over the next two months. To raise rates in June it will need to adopt a specific tightening bias at the May meeting.
The Reserve Bank Board decided to keep the cash rate target at 10 basis points and the interest rate on Exchange Settlement balances at zero per cent.
The Governor has significantly changed his language in the Statement to allow flexibility to start raising rates based on data “over coming months”. By definition, that could be as early as June, which would be two months earlier than our current call that the tightening cycle will begin in August.
In the conclusions to statements of recent meetings the Governor has concluded that “It is likely to be some time yet before growth in labour costs is at a rate consistent with inflation being sustainably at target. The Board is prepared to be patient as it monitors how the various factors affecting inflation in Australia evolve.”
In today’s Statement the Governor notes, “Over coming months, important additional evidence will be available to the Board on both inflation and the evolution of labour costs. The Board will assess this and other incoming information as it sets policy to support full employment in Australia and inflation outcomes consistent with the target.”
Note also, however, that it still remains cautious about the evolution of wages, “growth in labour costs has been below rates that are likely to be consistent with inflation being sustainably at target.”
In his Statement last month after the March meeting, he did refer to “labour costs” but in the Minutes of the March meeting the Board referred to the need for “aggregate wages growth to be consistent with inflation being sustainably at target.”
This is important because “aggregate” wages refers to the Wage Price Index, whereas labour costs can be a much broader measure covering business surveys; the RBA’s own liaison; and other “lead indicators” such as job vacancies; the unemployment rate and award wage decisions.
The arithmetic is that the annual growth in the Wage Price Index that prints on May 18 is likely to print 2.5% (0.8% for the quarter), well below the 3% target that the Governor has set in the past although the annualised six month pace is likely to be around 3%. (The annual rate is being held down by the 0.4% which printed in the June quarter last year. That will drop out for the June quarter reading but will continue to hold down the annual March reading.)
The Governor confirms the consistent view that the pick-up in wages growth is expected to be “only gradual”, although there is uncertainty about the behaviour of labour costs at historically low levels of unemployment.
The Inflation print on April 27 is forecast by Westpac to print 4.6% annual headline, up from 3.5%, and underlying annual 3.1% up from 2.6%.
Given the extreme impact of fuel prices on the headline print the underlying print will attract most attention from the RBA.
With the Statement referring to “over coming months” it seems clear that the Board is not signalling a likely move at the May meeting in the aftermath of the March quarter CPI.
However, it could move to a tightening bias at the May meeting dependent on the inflation print on April 27 and conditions in the labour market in May.
With the March quarter WPI; two prints on the unemployment rate; and business and liaison survey the Board has now sufficiently changed its language to satisfy the market which has been demanding a June rate hike for some time.
Even though the election in May posed some complications for monetary policy it appears from this change in rhetoric that the Board is prepared to accept that a specific debate about an immediate rate hike following the election on May 14 or 21 can be contemplated, emphasising the independence of the Reserve Bank.
Conclusion
We have been surprised with this very significant change of heart from the Board since the March meeting. The only important piece of new domestic data over the month has been the fall in the unemployment rate to 4% although developments in global markets have, as indicated by the market, been consistent with a much more aggressive RBA.
However there has been a major change in the rhetoric and the Board has now increased its flexibility to start raising rates as early as June, two months earlier than our current call which remains August.
