Stance of policy described as “clearly restrictive” and more prominence given to possible downside risks to growth but persistence of high inflation and tight labour market conditions still look to be the main factors shaping policy decisions in coming months.
At its July meeting the Reserve Bank Board considered two options for policy: to hold the cash rate steady or to increase it by 25bps. The minutes provide a detailed account of the arguments in favour of each of these options.
The case for a tightening is at its strongest when they point out that there is little spare capacity in the economy including in the labour market. Weak productivity and rising unit labour costs emphasise the risks to inflation associated with rising wages growth. This environment was assessed as being conducive to above average increases in prices and wages. The Board continues to highlight the stickiness of services inflation, both in Australia and offshore, and concerns that this development has extended tightening cycles in most countries. These arguments are consistent with the discussion around the decision to raise rates at the Board’s June meeting.
When central banks make decisions that are somewhat surprising they will always make a strong case to support that decision. These minutes are no exception with the case to hold rates steady strongly promoted. The current stance of monetary policy is described as “clearly restrictive”; a view backed by the inversion of the yield curve since April, which points to market expectations that rate hikes may have gone too far. Mortgage interest payments are estimated to be at record highs (9.4% of income) and are expected to increase further even if rates remain on hold – the full effect of policy tightening has yet to be felt.
In addition, the Board discusses downside prospects for their forecasts. An easing in labour market conditions might see current tightness ease more than expected while consumption may slow more sharply than implied in current forecasts. Under those circumstances, the unemployment rate would rise beyond the rate required to ensure inflation returns to target.
Despite this strong justification for rates remaining on hold in July, the Board still concludes that “some further tightening of monetary policy may be required” with that decision continuing to be contingent on how the economy and inflation evolve – data updates on inflation, the global economy, the labour market and household spending of particular importance alongside the full refresh of RBA staff forecasts due in August.
This increased prominence given to downside risks seems somewhat inconsistent with the data-flow since the June Board meeting – the March quarter national accounts in particular – but does again seem to emphasise the point that the case to justify a decision is always strengthened in the Board minutes.
As with last month, developments around inflation, employment, household spending, the housing market and global trends will be critical for the next decision in August. Westpac continues to expect that slow progress in reducing inflation, which is likely to be apparent in the June quarter inflation report, and ongoing tightness in the labour market, particularly as job vacancies remain historically elevated, will make the case for further tightening well justified. However, we cannot be unmoved by the strength of arguments put forward for the July decision to leave rates on hold, particularly new ones around the stance of policy, the shape of the yield curve and downside risks to the outlook. As such, we expect that, as with previous meetings, the August decision will again be balanced.
