The Minutes for the RBA May Board meeting highlight the importance of the Bank’s liaison surveys for assessing inflation challenges. Pricing power; labour shortages; and rising labour costs all support the decision in May. There is also some encouraging evidence that our call for a 40 basis point increase on June 7 is likely to be seen by the Board as the best policy.
The Minutes of the Reserve Bank Board meeting of May 3 emphasise just how important the Bank’s liaison surveys have been in framing policy.
Information from Liaison is attributed to highlighting to the Board that:
- “Firms’ price setting behaviours were undergoing a change from the pre – pandemic period, with businesses becoming more confident that raising prices would not significantly reduce demand or erode their competitive position.”
- “Labour costs were rising at a faster pace and this was likely to continue.”
- “The outlook for broader measures of labour costs had also been revised up … as firms turned to bonuses, allowances and other measures to attract and retain workers.”
- “Many firms were having difficulty hiring workers with the right skills.”
This accumulated evidence from the Liaison surveys and other business surveys justified the need to raise the cash rate in May before the standard Wage Price Index data printed on May 18 and the broader measures of wages growth (including average weekly earnings) that would print in the national accounts on June 1
The Minutes noted that “the recent evidence on wages growth from the Bank’s liaison and business surveys was clear.”
The Risks to the Outlook
The Minutes carefully outline the impressive list of risks to the Bank’s central case that “Inflation was expected to increase further in the near term but decline back towards the top of the target range by mid-2024 as supply side disruptions are resolved.”
These risks include:
- Uncertainty around how and when the supply-side problems would be resolved.
- Inflation pressures were also emanating from domestic pressures as there was limited but unknown spare capacity in the labour market
- The sensitivity of household spending and house prices to rising rates and declining real wages.
- The impact of the accumulated savings buffer and the high household savings rate to higher rates.
- The behaviour of prices and wages when the unemployment rate hits 50 year lows.
- The extent to which the reopening of the international border alleviates acute areas of labour shortages.
Policy
The Minutes outline the Board’s decision on the day. Three options were considered once it was decided to raise the cash rate.
The 15 basis points option which was favoured by most analysts and the market was dismissed by the Board because policy settings were already “very stimulatory”; further rate rises would be required; and a 15 basis point increase would be inconsistent with the historical practice of changing the cash rate increments of “AT LEAST” 25 basis points.
The case for 40 basis points “could be made given the upside risks to inflation and the current very low level of interest rates.” That case remained open without any real argument against it, although “given the Board meets monthly, it would have the opportunity to review the setting of interest rates again within a relatively short period of time”.
Taken, literally, that argument might justify never moving by more than 25 basis points.
It has been our argument that the move on June 7 should be 40 basis points. The lack of a clear argument against the 40 in May in the minutes and the fact that they refer to the level of rates being “very stimulatory” supports that case.
At his press conference the Governor referred to “business as usual”.
That may have been interpreted as “25 basis point movements.” However, the minutes imply that “business as usual” means movements of “at least” 25 basis points.
Another key argument supporting the likely 40 basis point policy is the description of the actions of other central banks in the minutes. “Several central banks in advanced economies had indicated that they were seeking to return policy rates to a neutral setting quickly and may increase policy rates further thereafter.”
But the minutes correctly note the significant uncertainty around the level of the neutral rate.
It is for that reason that we have advocated the policy of front end loading the tightening cycle with an immediate 40 basis point move – adopt a larger increment early in the cycle when it is clear that rates are well below that neutral level.
The minutes also set out clearly that the Board is unlikely to move away from its decision to not reinvest the proceeds of maturing bonds. Reinvesting the proceeds would not be consistent with the strength of the economy or the inflation challenge. Allowing an orderly run off would be gradual and predictable.
The Board argues that selling bonds would have a modest effect relative to raising the cash rate. And the balance sheet contraction would be assisted by the repayment by the banks of around $180 billion of the Term Funding facility by the banks and other DTI’s.
Conclusion
We remain comfortable with our forecast that the terminal rate in the tightening cycle will be 225 basis points.
But as the minutes highlight quite clearly there is formidable uncertainty around that target.
However, the minutes do provide some support to our view that the next move in the cycle on June 7 will be an increase of 40 basis points rather than 25.
40 basis points would not conflict with “business as usual”; the grounds for dismissing the case for 40 at the May meeting are not strongly made as is the case with the 15 basis point option; the minutes refer to other central banks wanting to reach neutral “quickly” while the uncertainties highlighted by the minutes do not really come into play until the cash rate is significantly higher than the current 35 basis points
We have also seen the slightly uncomfortable evidence that the Bank’s private liaison surveys are playing a critical role in their assessments of their task to bring inflation back to the top of the target band by 2024. The word “uncomfortable” refers to the fact that the Liaison surveys are not publicly available.
However, the overall messages from the Liaison surveys – a return of some pricing power to business; labour shortages; various non-wage methods used to attract and retain staff and fast increasing labour costs are unlikely to be credibly contradicted by the Wage Price Index (May 18) and Average Weekly Earnings (June 1), which are set to print before that June 7 meeting.
