Despite the strong case the Minutes point to the decision in May being “finely balanced” – this still argues for the next ‘live’ meeting being August.
The Minutes of the Reserve Bank Board meeting make a strong case for the surprise decision to raise the cash rate at the May Board meeting.
In interpreting these Minutes we must be mindful that when a central bank makes a decision that is not expected it will go out of its way to justify the decision.
The key change in the rhetoric which certainly enforces the case for the rate hike is the recognition that the current forecast for inflation does not have it reaching the top of the target band until mid-2025. In previous communications the Board made a virtue of that long period as the ‘price’ to pay for maintaining most of the employment gains of recent years. Now we are hearing that the strategy is risky, leaving “little room for upside surprises to inflation given that inflation would have been above the target for around four years by that time”. This risk, which has been part of the policy scenario since the Bank began the tightening cycle, now appears to be unnerving the Board.
The upside risks, which are not new, centre on: services inflation in other countries, which has been persistently high; strong population growth; upward pressures on rents; weak productivity growth boosting unit labour costs; and a potential shift in inflation expectations (although still no evidence so far that this is occurring, and actual inflation is now declining).
The Board now also points directly at asset markets, the pause in April seen as likely partly contributing to a lift in house prices and lower Australian dollar. Commentary on both of these links them to the outlook for activity and inflation rather than implying policy is targeting asset markets. Concerns about a wealth effect from the housing market at this stage of the cycle seem to be a marked over-reaction.
The case for a pause was familiar: weak consumption; rising aggregate mortgage rates as low fixed rate mortgages expire; and a forecast increase in unemployment that might see inflation slow more quickly than forecast. The argument here is to hold steady to gain more information.
Given this rhetoric it seems surprising that “the arguments were finely-balanced” rather than overwhelmingly in favour of the hike.
That ‘finely balanced’ assessment also seems inconsistent with the return in the rhetoric to the February approach of discussing multiple rate hikes, although the phrasing “are likely to be needed” is replaced by “may still be required”.
Also, in the concluding line of the ‘Considerations for monetary policy’ section – “Members also agreed that further increases in interest rates may still be required, but it would depend on how the economy and inflation evolves” – the phrasing ‘further increases’ has replaced ‘monetary policy may need to be tightened’ which comes across as stronger language.
So we are left with a somewhat confusing message. The decision was ‘finely balanced’ but the case for tightening was made much more strongly than the case to hold.
The importance of the clear slowing in activity and its implications for demand-related inflation pressures seems to be underplayed. There is now a ‘cost’ of pausing – boosting asset prices.
The attraction of pausing to assess the cumulative impact of the most rapid tightening cycle we have seen seems to have less weighting, e.g. “there was a case to hold the cash rate steady in order to gather more information.” And the high frequency of meetings no longer rates a mention.
How the productivity argument can impact the near term outlook for policy is not explained – productivity, which is driven by the supply side of the economy, will evolve over the medium term and should not be a factor affecting the immediate policy outlook unless the Board is convinced that Australia is set for an extended period of further productivity erosion in which case the tightening cycle would have significantly further to run.
Conclusion
We still expect that the Board will choose to pause at the next Board meeting on June 6. But the case for further near-term rate increases cannot be dismissed.
The concerns the Board has around the risks to its inflation target are understandable but so are the signals around the sharp slowdown in spending and the likely feedback this will have on inflation and labour markets.
As the Board has outlined, the decision in May was ‘finely balanced’, therefore given the relentless frequency of Board meetings the case for a pause in June is respectable.
However, unless we see data on wages and the labour market later in the week that shocks the Board the next ‘live’ meeting should still be August 2 when there will be more information on the Board’s progress towards its inflation target while evidence around the consumer slowdown will be clearer.
As was the case in May, the arguments in August will again be ‘finely balanced’ although our forecasts point to an ‘on hold’ decision.
