Contrary to widespread expectations RBA Board retains strong tightening bias.
The Reserve Bank Board lifted the cash rate by 0.25%. While that decision was strongly promoted by Westpac there was real uncertainty in markets with only around an 80% probability attached to it.
Markets were even more convinced that the Governor would soften his guidance with a weaker tightening bias.
In the event the Governor maintained the guidance he has used in the last two meetings , “The Board expects to increase rates further in the period ahead, but is not on a pre-set course.”
Options that were considered by some market participants included, “might increase”; “is willing to increase”; “will consider increasing”.
The use of the additional qualifier “but not on a pre-set course” seems neutral by allowing full flexibility in the context of a clear strong tightening bias and, in my view, does not weaken that bias.
From Westpac’s perspective those options would have been a misplaced strategy given that the next meeting is not until February 6 and the Board now has ample time to assess the cumulative impact of the rate increases from the perspective of household spending; the housing market; employment; inflation (December quarter CPI prints on January 25); the global economy; and private sector measures of wage inflation, (the next official ABS Wage Price Index does not print until February 15).
Over that two month period there will be at least two more previous increases in mortgage rates that will be passed on to households.
As usual there were few changes to the November Statement in the December Statement.
One that stood out was the Governor finally emphasising the dangers associated with high inflation.
In November he noted that “Price stability is a prerequisite for a strong economy and a sustained period of full employment” .
In December he has strengthened that theme. “High inflation damages our economy and makes life more difficult for people”.
Perhaps the October and November Statements were justifying decisions to move by only 25 basis points so the arguments about the economic damage from high inflation were downplayed in favour of the key point regarding the lags from monetary policy.
From our perspective it is encouraging that the Governor has emphasised his awareness of the dangers of entrenched inflation – consistent with the views of other central banks such as the Federal Reserve.
That point was further emphasised where he notes that “The Board’s priority is to establish low inflation and return inflation to the 2-3% range over time. ”That point emphasises that the Board’s objective around inflation is for sustained low inflation.
Further on inflation , he did recognise the monthly inflation report by noting that annual inflation was 6.9% ( as reported for October) but was prepared to confirm the Bank’s view that inflation would reach 8% by year’s end.
Given that the October report only covers 43% of the components by value then it was reasonable that the Governor may have delayed recognising the result until further information was available.
The sharp lift in private sector wages growth in the September quarter may also have impacted the Board’s thinking.
The Governor notes that “ wages growth has continued to pick up “ but unlike in November excludes the qualification that “ remains lower than in many other advanced economies.”
Given the strong wages (including yesterday’s report for the September quarter)and employment reports since the last Board meeting it is surprising that the Governor did not repeat the sentiment from the November Statement that “people are finding jobs, gaining more hours of work and receiving higher wages.”
Conclusion
The Board has correctly maintained a strong tightening bias while emphasising the uncertainties in the outlook.
There is a stronger recognition of the dangers around high inflation than we have seen in previous Statements when 25 basis point moves needed to be justified.
Westpac expects that the inflation report for the December quarter will signal the need for further tightening and the Board will act on its tightening bias with a 25 basis point increase in February.
Beyond February we expect further increases in March, in response to the December Wages Report, and May to achieve the clearly stated objective of “Board’s priority is to re-establish low inflation.”
We are surprised that market pricing still includes some likelihood of rate hikes in the second half of 2023. Our forecast of 1% growth in 2023, partly contingent on our view on the Bank’s tightening cycle and the difficulties in wringing inflation out of the system, implies that the economic slowdown will be particularly intense in the second half precluding the need to tighten further.
The risk, which seems lessened following today’s decision and statement would be that insufficient policy tightening allows elevated inflationary expectations to become embedded in the Australian psyche.
