RBA on hold as expected, recognising the data has broken against its hawkish narrative. Base case clearly an extended period on hold, but RBA will hike if upside risks to inflation materialise.
- As widely expected, the RBA Monetary Policy Board (MPB) kept the cash rate on hold at 4.35% at its August meeting. The accompanying statement highlighted that the MPB is prepared to increase the cash rate from here, if upside risks to inflation materialise. This is more specific and narrower language than in May, when it was stated that the cash rate would be increased “if needed”.
- The RBA has evidently concluded that the base case is that rates are on hold. Headline and trimmed mean inflation have both come in lower than the RBA expected in May, and the labour market and housing market are both weaker than it expected. Pass-through of higher energy prices came in quickly and in size – as we flagged at the time. But as we noted in our change of rate call, this pass-through has since tapered off, undershooting the RBA’s expectations.
- This decision is a hold of a different character to June’s meeting, where a hike was not even contemplated because the MPB was in “wait and see” mode ahead of the Q2 CPI. This month’s decision involved consideration of a hike, but the base case forecasts, which show inflation below the target midpoint by 2028, did not really support such a decision.
- Softer inflation and labour market outcomes have strengthened the assessment that monetary policy is somewhat restrictive, a judgement the RBA had less confidence about earlier in the year. Still, the RBA is looking for a period of below-trend growth, and ultimately some spare capacity to build up, to engineer the reduction in inflation. Currently its forecasts show the economy to be on track to deliver that outcome.
- The MPB is not yet ready to rule out rate hikes, however, because it assesses that inflation risks are skewed to the upside. It is particularly concerned that pass-through from energy prices to other prices might continue, even though it has eased off a bit sooner than originally expected. Further escalation in the Middle East conflict might result in higher energy prices than forecast, and/or more pass-through. These are similar considerations to the ones that led us to flag that there was still some chance that the RBA hikes again this cycle, even though that is no longer our base case.
- The RBA still assesses the labour market to be somewhat tight, although it has eased recently. However, some of the measures the RBA typically relies on for this assessment have been affected by changes to the Labour Force Survey; measures that do not involve this survey such as capacity utilisation and business difficulty finding suitable labour provide a clearer easing signal. The SMP highlights underemployment as supporting the assessment that the labour market is still tight. As we have previously noted, other measures of underemployment published by the ABS have increased more sharply than the headline measure. The RBA’s evolving assessment of labour market conditions will be a key driver of its inflation outlook, arguably more so than the housing market, which is also being affected by changes to taxation arrangements.
- The RBA’s underlying analysis that capacity pressures are boosting inflation and constraining output growth remains in place. Although the RBA’s assessment of potential output growth is a little higher than in recent quarters, the revision was driven solely by a revised outlook for population growth. The RBA’s downbeat assumptions about trend productivity growth have not changed, despite extensive language in the SMP highlighting the boom in AI and data centre investment, which has been stronger than its forecasts recognised in May.
- Curiously, the SMP highlighted the inflationary risks posed by the AI boom pressuring construction capacity at home and semiconductor-related inflation globally, despite not factoring in any positive productivity spillover from the resulting investment. While productivity benefits would be expected to come through with a lag, how long this was expected to take was not addressed. We also find it curious that the SMP and Governor highlighted the contention for construction labour and other resources this involves, but the effects of this are only barely evident in its GDP forecasts. This implies a view that data centre construction must be crowding out other construction.
- We continue to expect the RBA to remain on hold through to mid next year. However, it will be a “hawkish hold” with the MPB slow to relax given its view that upside inflation risks predominate. While we believe that investors should allow for some risk of a hike later this year, it is not our base case. There are clearly upside risks to inflation, as the RBA has highlighted, but in our view downside risks as well.
