The Governor’s Statement points to his assessment that policy has now reached neutral – best step now is to slow the pace to 25 basis points next month.
The Reserve Bank Board decided to increase the cash rate by 50 basis points to 2.35%.
The most important change in the Governor’s Statement is the changed description of the tightening cycle.
In previous statements he has referred to the rate increases being “a further step in the normalisation of monetary conditions”. In today’s Statement the “normalisation” concept has been removed.
“Normalisation” can be interpreted as moving policy towards a neutral setting. In previous speeches the Governor has described “neutral” as being at least 2.5%.
In not referring to this move as a step towards “normalisation” we can, arguably, conclude that, consistent with the 2.5% estimate, he now believes he has moved policy to that neutral setting.
It has been our view that policy should quickly move to neutral and then move more slowly as policy traverses through the contractionary settings.
That slower pace would imply a step back to 25 basis point moves going forward.
Some support for the concept of being a little more cautious with rate moves is provided in the comment “the full effects of higher interest rates yet to felt in mortgage payments.”
If we are right, it does not mean that the Governor believes he is close to his policy objective.
The Statement intensifies concerns around the labour market. In August, “tighter than it has been for many years”; in September, “the labour market is very tight and many firms are having difficulty hiring workers”. Furthermore, in August he noted, that liaison points to “a lift in wages growth.” In this Statement “some pockets where labour costs are increasing briskly”.
There is also some recognition of the strong emphasis on the priority of inflation over growth similar to the theme we saw in the Jackson Hole speech by FOMC Chair Powell, “Price stability is a prerequisite for a strong economy and a sustained period of full employment.”
If we had seen “not on a pre set path” for the first time in today’s speech then the case for scaling back to 25 basis points would be even stronger but, of course, that term has been used in previous Statements. However, it takes much greater significance now that the Governor believes that the normalisation objective has been achieved.
Note that the Statement also points to “The Board expects to increase interest rates further over the months ahead”.
Maintaining a “50 basis point” pace, when he accepts that there are lags with respect to the household sector would seem to be unnecessarily risky given the high frequency of the Board meetings (for example RBNZ has seven meetings a year compared to RBA’s eleven).
He does not need to move unnecessarily quickly into the contractionary zone when he recognises the importance of lags and is forced to pause too soon.
But the language around the priority of inflation; labour markets; and wages does not seem consistent with an imminent pause and the risks around inflationary expectations that could materialise through a premature pause.
The better approach, now that neutral has been reached, is to maintain the emphasis on inflation being the central commitment while backing that up by continuing to tighten policy.
Conclusion
We confirm our view.
Today’s decision and the associated Statement seems to be most consistent with a scaling back to 25 basis point moves from October but maintaining that sequence for a number of consecutive meetings out to February next year with a peak terminal rate of 3.35%.
