The Board has paused but the reasons we have given to support our call for a hike in July remain. Target terminal rate still 4.6% with 25bp hikes expected in both August and September.
The Reserve Bank Board held the cash rate steady at 4.1% at its July meeting.
The reason was: “to provide some time to assess the impact of the increase in interest rates to date and the economic outlook”.
This is the same wording used following the decision to pause in April.
Reference to the outlook seems related to the Board awaiting the staff’s revised forecasts that will be available for the meeting in August.
Note the recent pattern: a pause in January (when there was no meeting); increases in the next two months – February and March; a pause in April – increases in the next two months – May and June; and a pause again in July.
April and July are the months immediately preceding the quarterly inflation report and the Statement on Monetary Policy, which sees the staff update its forecasts for the Board.
Westpac lifted its forecast for the terminal rate to 4.6% following what appeared to be a clear rebalancing of the Board’s reaction function at the June Board meeting – placing central emphasis on containing inflation pressures and wage/price expectations and less on protecting the employment gains since the pandemic.
This point continues to be emphasised in the Governor’s decision statement, which abandoned the concept that had been used in previous statements – “The Board is seeking to keep the economy on an even keel …” – in favour of a more cautious: “The Board is still expecting the economy to grow …”.
Westpac had expected the Board to raise rates again in July, reflecting this assessed change in its reaction function and the data flow, which has included evidence of an ongoing tight labour market; emerging wage pressures; sticky underlying inflation; and a sustained upswing in the housing market.
Of most significance was the Deputy Governor defining the Bank’s measure of full employment as 4.5% – the rate required to achieve the inflation target – which is a long way from the 3.55% that printed in May.
The decision by the Board to pause pending further data does not change the assessment that further tightening is required, including our expectation that the terminal rate will need to reach 4.6%. Notably, the line that “Some further tightening of monetary policy may be required …” was repeated in the July Governor’s statement, having been omitted in the minutes to the June meeting but included in the June decision statement.
The language remains consistent with rate increases of 0.25% in both August and September, which is now our call.
But unlike the pattern we have seen so far this year we do not expect a follow-up hike in November after the next pause in October.
Our forecasts suggest progress on bringing down inflation, and evidence of some easing in labour market conditions and of very weak demand will allow the Board to remain on hold after September. The opportunity to ease policy will eventually come once the Board is confident that a sustained return to low inflation has been achieved.
We confirm our call that, following the hikes in August and September, rates will remain on hold until May next year when conditions will allow the Board to begin easing.
Conclusion
The clear signal from the June Board meeting that motivated our call for a follow-up move in July has been tempered by today’s decision to pause. Despite this, there remains a strong case for rates to go higher, a message that is still apparent in the Governor’s decision statement.
Following the June meeting we raised our forecast for the terminal rate to 4.6%. That still holds, with hikes now coming in August and September, but thereafter we expect that the evidence will be clear enough that the Board can be patient as inflation pressures ease and the economy stagnates.
