The RBA’s strategy relies on assessing gaps between supply and demand. There are uncertainties involved in this approach, but so far, the inflation outlook hasn’t changed enough to spur a rate increase.
The minutes for the RBA Board’s June 2024 meeting highlighted that levels matter in the RBA’s view of the economy, as well as growth rates. The brief section on international developments noted that it was the economies with negative output gaps (where aggregate demand is below aggregate supply), such as Canada and Sweden, where services inflation was still declining. On the domestic side, the minutes started by noting that the staff assessed that ‘aggregate demand had continued to exceed aggregate supply’. Likewise, the labour market ‘was still assessed as tight relative to full employment’. Both the output gap and the labour market tightness were assessed as narrowing.
The discussions on considerations for monetary policy are increasingly being framed as assessments of these gaps. This is not a complete departure from past approaches, but as the apparent gaps narrow, the evidence base for these estimates will face intensified scrutiny. So will the Board’s assessment that global growth has troughed, noting the current uncertainties around trade policy and geopolitics more broadly.
Given the uncertainties around these ‘gap’ estimates, the point at which the gaps are assessed to have closed will be something of a judgement call, a point acknowledged in the minutes. The June quarter CPI and the revised forecasts will, therefore, be important inputs to the August Board meeting.
One point to watch in future RBA communication is how the central bank reconciles its view that the labour market is still tighter than the full employment level, with its view – which we share – that wages growth has peaked. The minutes also noted the easing in growth in unit labour costs, as has been previously highlighted by Westpac Economics colleague Pat Bustamante. These developments might help explain why the Board highlighted that it was not following the practice of other central banks in assuming that ‘some spare capacity was necessary to bring inflation back to target within a reasonable timeframe’.
The RBA had been surprised by the stronger durable goods inflation in the April inflation indicator. However, there was little new information on services inflation, which has been more of a focus recently. The May monthly inflation indicator, which was released after the meeting, was above consensus, but the services component showed further moderation; that said, the pace of decline is slow, as it has been overseas. Again, we expect that the Board will look to the full quarterly data to form a revised view.
The minutes highlighted an increased risk that inflation could take longer to return to target than previously expected. However, actual outcomes implied that ‘the economy was still broadly tracking on a path consistent with returning inflation to target in 2026’. If future developments point to this no longer being the case, the Board would act. But as the output and labour market gaps narrow, the case to take out insurance against heightened perceived risks alone would weaken.
The revisions to overseas holiday spending were seen as bringing household consumption behaviour more in line with past relationships. But the implications for future household spending are not clear. The implied level of household saving is now very low, though this is often revised and extra payments into mortgages are higher than the pre-pandemic average. There is probably a distributional angle here; the minutes do not tease this out but did mention ‘clear evidence that many households were experiencing financial stress’. Also noteworthy in the minutes is the mention of household debt growing more slowly than incomes, especially once extra payments into offset accounts were included.
Several of the developments mentioned in the minutes highlight the awkwardness of the current policy environment. This is not a situation of needing to lean against strong private sector demand that is driving inflation higher. Rather, we see weak demand and declining inflation. The policy decision therefore rests on views on whether demand is weak enough to bring inflation down fast enough, given the factors working in the wrong direction.
Among these factors, it is noteworthy that the minutes highlighted the role of public sector demand in driving both GDP and employment growth. In addition, the minutes noted that if aggregate supply were more constrained than previously assumed, this might also strengthen the case to raise rates. Ongoing slow (but positive) productivity growth was also highlighted. If that scenario does play out, the case for other policymakers to do what they can to repair the supply side becomes more urgent.
Overall, these minutes confirm our view that the Board would raise rates if the outlook shifted to imply a slower or stalled decline in inflation. But it has not come to that point yet. And given the increased focus on the Bank’s full employment mandate, one can readily imagine that the Board is hoping that it doesn’t come to that point, either.
