RBA Minutes reprise inflation and capacity concerns but downplay the USD sell-off’s role in the AUD’s appreciation.
- In recent times, RBA minutes have typically added little information beyond what is already discussed at the media conference or published in the Statement on Monetary Policy (SMP). This time, though, the minutes highlighted how poor model-based measures of the ‘neutral interest rate’ are as a guide for policy.
- More concerningly, the minutes were quite dismissive of the exchange rate’s role in holding down inflation. It is true that much of the recent appreciation in the AUD reflects the changing interest rate outlook and so is already in the (small) disinflationary impact forecast from that source. However, the exogenous-to-Australia sell-off in the USD and associated hedging behaviour is an independent element that the RBA seems not to have allowed for. While this will not become apparent for a while, it does suggest some downside risk to imported goods inflation.
- The bulk of the minutes were devoted to concerns about capacity pressures and the (smaller) proportion of the recent pick-up in inflation that was potentially persistent, which were already canvassed in the RBA’s other communication. The risks around the market path for interest rates were seen as two-sided, depending on how demand pressures and supply constraints evolve from here.
With the advent of media conferences after every meeting, RBA minutes have tended to provide less information value of late than in the past, particularly for SMP meetings. This time around, there were some interesting points that could point to under-appreciated risks for the policy outlook.
Their assessment of financial conditions was quite backward-looking, especially around credit. Credit responds to interest rate and economic conditions with a lag, so strong credit growth now tells you about conditions a little while ago, when rates were expected to fall further. While the higher exchange rate tightened financial conditions at the margin, there was considerable scepticism in the minutes about whether financial conditions at the beginning of this year were tight in an absolute sense.
There were also some inconsistencies in the discussion of financial conditions and the stance of policy as it related to inflation risks. The Financial Conditions section of the minutes pointed to the pick-up in inflation as a sign that policy was no longer restrictive, because it implies demand is outstripping supply. In the Economic Conditions section, though, it was stated that “the larger part of the increase had reflected less-persistent factors, including price volatility in categories such as electricity, travel and groceries,” none of which provides information about demand pressures. Of the factors mentioned in that passage, only durable goods inflation would normally be thought of as signalling demand pressures rather than transitory supply shocks or seasonality. Some of the pick-up in inflation is seen as indicating demand and capacity pressures, but not “the larger part”. This nuance was missing from the discussion of the policy stance, which could either be a (rare) drafting oversight or a hint at differences in opinion within the RBA staff (and possibly also Board members).
In welcome news, the minutes really tried to hose down excessive focus on model-based measures of the so-called ‘neutral interest rate’. This should resolve some confusion among observers. A comment about these measures being regarded as a “misleading signal of the stance of monetary policy prior to the pandemic” was new information. It should be noted that most major central banks have not come to the same view.
More concerningly, the minutes were dismissive of the idea that there has been any exogenous element to the recent exchange rate appreciation. According to the minutes, essentially all the exchange rate move has been the result of higher interest rates and commodity prices, and so the currency is assessed to have had no independent effect on imported prices beyond the interest rate impulse response, for example as traced out in Figure 12 of this RBA research paper. In the ‘Considerations’ section, it was stated “the appreciation had been in response to expectations for tighter monetary policy, not independent of it.” The minutes also stated that “The forecasts also accounted for the 5 per cent appreciation of the exchange rate since November, which was assumed to dampen import prices and net exports.” Observant readers will notice that the AUD appreciation over the past month has been at least double the amount implied by that research paper figure across two different models, for a similar shift in (expected) interest rates.
As we noted last week, we think that some part of the AUD appreciation is in fact the result of the USD selloff (and CNY counterpart), amplified by hedging activity, making it independent of the response to rates and commodity prices. Timing issues might have contributed to the RBA’s judgement on this point, given how close the sharpest part of the appreciation was to the 28 January deadline for finalising forecasts. However, there is also an analytical point here that the RBA’s assessment in the minutes explicitly rules out. If it had just been a deadline issue, the language in the minutes would have been more circumspect.
This part of the appreciation is a source of downside risk for inflation over the next year or so that the RBA have clearly missed. We expect to have a more refined estimate of this impact soon but currently assess the potential impact as being similar to that of interest rates, i.e. of the order of 0.1–0.2ppt off trimmed mean inflation over the next year or so.
The bulk of the minutes was dedicated to the changed assessment of demand and capacity pressures in the economy, and the resulting inflationary impact. Much was made of the staff’s model-based measures of spare capacity, which had been revised considerably since the previous meeting and now matched up better to the results in a leading business survey. (Unlike the models of the neutral rate, this variability was represented to be a good thing.)
Breadth-based measures of inflation were key to the RBA’s concerns about renewed inflation, even as the “larger part” of the pick-up in inflation was seen as mostly temporary.
Like other recent RBA communication, the minutes were circumspect and agnostic about the outlook for the cash rate from here, with risks on both sides of a market path that the minutes seemed to broadly endorse. Some downside risks had abated, notably those concerning global growth. Weaker demand growth, stronger supply capacity growth, sector-specific shocks or a misreading of the stance of policy were all cited as downside risks. On the upside, most of the same factors applied in reverse, along with the question of whether longer-term inflation expectations remained anchored. It should be noted that the recent speech by Assistant Governor Hunter highlighted that the RBA’s updated analytical framework for assessing the labour market assumes that inflation expectations are anchored, so there are some potential inconsistencies in the (low-probability) event that this risk is realised.
The broader strategy of “seeking to bring inflation back to target within a reasonable timeframe while preserving as many of the gains in employment as possible” is still seen as appropriate by the Board. We see this as signalling that the RBA is not pivoting to an inflation-only view. Rather, its policy decisions are better characterised as fine-tuning the setting of policy in light of what the Board sees as shifting risks. This adds weight to our base-case view that the next increase in the cash rate is coming in May, not March.
