Monetary policy is working to bring demand and supply back into alignment and inflation back to target, and some of the concerns that would support a case to raise rates further were effectively dismissed by data released after the meeting. The Board’s decision to hold was therefore vindicated by subsequent events.
The minutes of the December meeting of the RBA Board highlighted the benefits of testing your assessment of the economy against subsequent data. Monetary policy is working to bring demand and supply back into closer alignment and inflation back to target, and some of the concerns that would support a case to raise rates further were effectively dismissed by data released after the meeting. The Board’s decision to hold was therefore vindicated by subsequent events.
The RBA Board was encouraged by global inflation news, noting towards the end of the minutes that the pace of disinflation had picked up in some economies. Labour markets and wages growth were moderating, more so in Europe than the United States. Services inflation can be expected to continue to decline, even if the pace has been slow to date, which is a promising sign for Australia. Slower global demand was also resulting in lower oil prices, another good sign for global inflation. The news in China was also a bit more positive than a few months ago; outside the property sector, the broader situation is still supporting iron ore prices.
Domestically, there was not much news, and what was available at the time of the meeting was not view-changing. The October CPI indicator contained little new information on the services prices that are the RBA’s current inflation concern. The Board did strike a note of caution about the balance of risks on wages growth ‘shifting a little to the upside’, with wages growth reaching 4% ‘a little sooner than had been expected’. But it also described wages growth as ‘unlikely to rise much further’ and ‘peaking at around 4 per cent by the end of the year’; the RBA’s November forecasts have growth in the Wage Price Index still at 4% over the year to June quarter 2024 as well. It is important not to make too much of small wording nuances or forecast adjustments, but this does suggest that the shifts in risks that the Board noted are small indeed. The Board’s discussion of labour market conditions noted that these were less tight and likely to ease further in coming months, with a risk that unemployment could increase by more than forecast.
As has been the case for several months, the Board considered both the case to raise rates and the case to hold them steady. Key to the case to raise rates was the assessment that ‘domestic demand was judged still to be running above the level consistent with the inflation target’.
Following the Board meeting, though, we have seen the release of the national accounts for the September quarter, which were noticeably softer than expected, especially for household consumption. The December Labour Force Survey also showed a workforce offering more labour supply in an attempt to counteract cost of living pressures. These subsequent developments cut against the narrative in the minutes of below-trend output growth having negative implications for productivity, at least beyond the quarter-to-quarter noise. They also cut against the depiction of business investment as still being strong (see Westpac Economics’ note on the national accounts).
The argument that ‘growth could be supported in the year ahead by a recovery in real household disposable income as inflation declined’, cited as part of the case for a rate increase, also seems optimistic in light of subsequent information. Board members acknowledged that consumption growth was weak and that the household sector was being squeezed by the higher cost of living and higher interest rates – politely omitting the role of taxation in reducing real household disposable incomes. While policy needs to be forward-looking, there is also a risk of getting ahead of oneself, and worrying about a turnaround in household incomes does seem like an example of this. The emphasis in the minutes on the share of household income going to interest payments being lower than in 2008 also seems misplaced. Real household disposable income was not falling in 2008.
As a possible nod to the recently released Statement on the Conduct of Monetary Policy, the minutes noted that financial stability considerations were not a constraint on monetary policy at present. The Board also explicitly noted that the November forecasts saw inflation returning to the top of the target band by end-2025, rather than the midpoint of the band. This suggests a more rigid interpretation of the Statement than the actual text implies. There is nothing in the text of that agreement specifying a fixed horizon for achieving the target. Rather, it says ‘The appropriate timeframe for this depends on economic circumstances and should, where necessary, balance the price stability and full employment objectives of monetary policy.’ If the Board were to shift the goalposts on its ambition for disinflation, it would need to explain how that fits in with its full employment objectives and the squeeze on household incomes. That would require explicit communication separate from the minutes.
In the end, though, the Board found the case to hold rates steady to be stronger than the case to raise rates. Inflation is declining and, so far, inflation expectations remain consistent with target. While there is a risk inflation comes down too slowly, there is also a risk – in our view partly realised in the September quarter national accounts – that aggregate demand slows more than expected.
The post-meeting data releases rendered much of the analysis in the minutes stale. The Board will need to incorporate a fresh assessment of the outlook for domestic demand ahead of its February meeting, as well as the November and December reads on inflation. Unless these inflation data are noticeably higher than expected (we are forecasting CPI +0.8%qtr, +4.3%yr; trimmed mean +0.9%qtr, +4.4%yr), we see the case to raise rates in February as having been weakened by the recent data flow; we continue to see it as more likely that rates will be held steady following that meeting. While the minutes highlighted a range of possible upside risks to demand and inflation, some of these seemed quite low-probability given experience overseas.
The minutes also discussed the Bank’s approach to reducing its bond holdings. The Board agreed to continue with passive run-off via bond maturities, rather than sell actively (so-called ‘active QT’). The decision was discussed in the context of the coming maturity of the bulk of the Term Funding Facility. There is also a bunching of maturities in April 2024, which had been the target bond for part of the period that yield targeting was in place. We take from this discussion that active sales of bonds are not on the table until these bunched maturities have passed. The question of whether active QT should be considered after that point is a separate issue and depends on the broader framework for monetary policy implementation. That framework will need to articulate the costs and benefits for the public interest of reducing the interest rate risk on the central bank’s balance sheet.
