The Board sees increased inflation risks while recognising prospect of weakening economy. And rising unemployment rate.
The Minutes from the Reserve Bank Board’s meeting in June provide a more balanced approach to the outlook for rates than we saw in the Governor’s statement following the decision to raise the cash rate by 25 basis points.
Of some significance is the absence of the sentence, “Some further tightening of monetary policy may be required to ensure that inflation returns to target in a reasonable time frame.”
That sentence was used in both his Statement and in his speech the following day to a bankers’ forum. It seems somewhat strange that the Governor would repeat the sentence on two occasions but the Board chose to exclude it from the Minutes.
The Minutes did conclude that the Governor’s speech the following day “would provide an opportunity to explain the decision in more detail.” So we should reasonably conclude that the “some further tightening” is still on the Board’s radar.
Less surprising is the description of the tightening decision as “finely balanced”. This is a fairly common description of decisions when we are nearing the end of the tightening cycle.
The Board considered two options – raise the cash rate by 25 basis points or hold rates steady.
The key theme from the Governor’s statement that the balance of risks on inflation had shifted to the upside (compared with a month earlier) was confirmed in the Minutes.
These direct risks are set out as: the monthly indicator of headline inflation had shifted to the upside in April; the decline in goods prices inflation had been less than observed in other countries; and services price inflation had not yet shown signs of moderating.
But concerns around wages growth seemed more acute: “the possibility of implicit indexation …to become widespread… [while] some members observed that some firms were indexing their prices.”
In addition the Annual Wage Review decision of the Fair Work Commission was higher than expected … and a range of public sector enterprise agreements were being negotiated and were likely to contain wage rises in excess of 4% for the first year. Concerns were also raised that “a broad range of jobs were to become implicitly indexed to high inflation.”
There is also specific concern around the housing market with the unexpected resumption of growth in house prices implying less of a drag on spending. Further, the stabilisation of housing loan approvals suggested that financial conditions “may not have been as tight as previously judged”.
Despite the rate increase in June the Westpac Melbourne Institute Index of House Price Expectations stabilised in June at a very high level, while auction clearance rates have remained high despite a marked lift in turnover. When the Board meets again on July 4 it is likely to be discussing another month of housing buoyancy.
There is ample recognition of the impact on households of rising rates, highlighting the risk that the economy slows and unemployment rises by more than expected. But the key remains that tight labour markets are inconsistent with the higher unemployment rate required to be consistent with the inflation target.
Conclusion
Westpac expects a follow up rate increase in July. This will be based around the key theme from the Minutes that the risks to achieving the inflation target have increased. It seems unlikely that concerns around indexation; sticky services inflation; and rising house prices will dissipate in one month.
Nevertheless it is curious that the Minutes did not repeat “some further tightening of monetary policy…” while there is clearly concern around household spending.
Since the Board meeting Compensation of Employees was reported to have lifted by a hefty 2.4% in the March quarter; while GDP lifted by a tepid 0.2% – around expectations.
The May Employment Report with an increase of 76,000 jobs will continue to see concerns at the RBA around a tight labour market raising those issues with respect to higher than acceptable wages growth, especially concerns around indexation. This concern around tight labour markets was emphasised by Deputy Governor Bullock today when she referred to employment being above what is consistent with the inflation target – more evidence that upside risks to inflation are sustained.
We still have to see the May Inflation Report – it is a little surprising that the Board gave reasonable emphasis to the April report given it excludes so many components of inflation. We will be watching that report but it seems unlikely to be a “game changer” given the Board’s clear recognition that inflation risks have increased.
Westpac confirms its expectation that the Board will raise the cash rate in both July and August.
