Via Kieran Davies, Chief Macro Strategist, Coolabah Capital Investments:
RBA Governor Lowe delivered a very important speech yesterday on “The recovery, investment and monetary policy” at the AFR’s business review conference. Arguably the biggest take-aways from the speech were:
- The RBA has materially revised down its estimate of the fully-employed jobless rate – proxied by the non-accelerating inflation rate of unemployment or NAIRU – down from around 4.5% to the low 4s, with Governor Lowe stating it could be in the 3s (Coolabah’s CIO, Christopher Joye, argued the NAIRU might be in the 3s in the AFR last weekend as did the AFR’s economics editor John Kehoe a few days later);
- The RBA doubled down on yield curve control, dismissing economist and market forecasts that they will drop it this year, and strongly rejecting market pricing of rate hikes commencing later next year as Lowe argued rates are likely to remain near zero until at least 2024;
- The RBA has again clearly signalled that a third round of QE, or QE3, will come after the second $100bn QE2 tranche expires in September, in line with Coolabah’s long-held forecasts, and further communicated its willingness to temporarily increase QE if required to smooth market disruptions; and
- The RBA reiterated that it is singularly focused on getting the jobless rate down to the NAIRU, which is in the low 4s and possibly in the 3s, to lift record-low wages growth of 1.4% to over 3% to finally return core inflation to the RBA’s 2-3% target band. This key driver of RBA policy is something that Coolabah has repeatedly stressed in its advice to clients, with history suggesting it will take considerable time and substantial monetary stimulus to achieve this goal.
On the all-important topic of where the NAIRU currently is, Lowe argued in his speech that:
“There is, inevitably, some uncertainty about exactly what constitutes full employment in our modern economy. Over the past decade, the estimates of the unemployment rate associated with full employment have been repeatedly lowered both here and overseas. So there is uncertainty. But based on this experience, it is certainly possible that Australia can achieve and sustain an unemployment rate in the low 4s, although only time will tell (emphasis added). As we progress towards full employment, we will be relying on the wages and prices data to provide a signal as to how close we are. The current signal is that we are still a long way away from full employment.”
Then in the Q&A session, Lowe was asked by the AFR’s John Kehoe whether the NAIRU might be 3-point-something, which Lowe acknowledged was entirely possible:
“AFR’s Kehoe: … Is that something you reconsidered, that the NAIRU might be lower, is it even possible that the discussion now going on that the NAIRU might even have a 3 in front of it? That it might be below 4%. You might need to get unemployment below 4% to get wages growth up towards 3%.
RBA’s Lowe: It’s entirely possible. None of us know. There’s a huge amount of uncertainty. Here we haven’t been with such low rates of unemployment for a long period of time and there are a lot of structural factors going on. So we can’t be sure. What I am sure of is that the unemployment rate needs to be below 5. How far below 5, it’s hard to tell and I certainly hope, and it’s not inconceivable, that we could sustain an unemployment rate in Australia starting with a 3. But we’re a long way from that. So we’ve got a bit of time to learn, we’ve got a bit of time to study the experience of other countries. I suspect given the fiscal developments in the United States they’ll get down to these low rates of unemployment before us and we’ll, as if have done in the past decade, see what happens there and learn lessons from it. (emphasis added).”
On the detail of his speech, Lowe emphasised that:
1. The cash rate will stay on hold at 0.1% until actual inflation was consistent with the 2-3% target. This is an “evolution” (sic) from the previous approach of relying more on forecast inflation when setting interest rates;
2. Wage growth will need to be sustainably above 3% on the wage price index measure for inflation to be sustainably within the 2-3% target band (or, on Coolabah’s calculation, above 4% for the broader GDP measure of wages used in the RBA’s inflation model);
3. The RBA very strongly disagrees with market pricing for rate rises starting as early as late 2022 and again in 2023, with the cash rate “very likely to remain at its current level until at least 2024” given the RBA’s judgement that “we are unlikely to see wages growth consistent with the inflation target before 2024”. In particular, Lowe noted that “over the past couple of weeks market pricing has implied an expectation of possible increases in the cash rate as early as late next year and then again in 2023” roundly rejecting this with the comment “this is not an expectation that we share”.
4. Lowe stressed that “we are a long way from a world in which growth is running at 3% plus”, where local and overseas evidence strongly suggests that “the journey back to sustainably higher rates of wages growth will take time and will require a tight labour market for an extended period”. This view reflects the common experience of weak wages growth in the advanced countries that has been driven by powerful and persistent structural factors, such as globalisation and technological advances;
5. The RBA will ignore transitory fluctuations in inflation, such as relative price shifts during the pandemic and higher food prices after a long drought, noting headline inflation will soon temporarily exceed 3% as weak pandemic-affected outcomes drop out of the annual calculation;
6. The RBA is aiming for “an inflation rate of 2 point something” and “the maximum possible sustainable level of employment in Australia”. The RBA now thinks full employment could equate to “unemployment rate in the low 4s” (previously around 4.5%) and in the Q&A session said it was conceivable that it was sustained in the 3s. The RBA would rely on wages and prices data to provide a signal as to how close Australia is to full employment;
7. The RBA rejected the widely-held market and economist view that they will drop the 0.1% target for the 3-year bond yield, with Lowe clarifying that “consistent with the judgement that the condition for an increase in the cash rate is unlikely to be met before 2024, the Bank remains committed to the 3-year yield target”. For the avoidance of doubt, he continued, “we are not considering removing the target or changing the target from 10 basis points”;
8. On the equally-contentious subject of whether yield target will become date-based using the April 2024 government bond or extended to the November 2024 bond, Lowe said, “the Board has, though, discussed the question of whether to keep the April 2024 bond as the target bond, or to move to the next bond – that is the November 2024 bond – later this year”. He added that the RBA would, “consider again later in the year when it has more information about the economic recovery and the labour market”;
9. The RBA would consider further extending QE later in the year as it is “prepared to undertake further bond purchases if that is required to reach our goals”. In the meantime, the RBA remains prepared to alter the timing of purchases depending on market liquidity and functioning, as was the case when it bought more bonds last week. Lowe added that the argument for further stimulus was being considered at each board meeting, where the “general principle” was whether sufficient progress was being made towards target and if the RBA could “accelerate that progress in a helpful way”; and
10. The RBA is carefully watching the strong recovery in the housing market, where the Council of Financial Regulators – which is chaired by Lowe – could deploy prudential measures if a deterioration in lending standards led to a “speculative boom”.
Coolabah’s view remains that the RBA will launch QE3 later this year and will likely implement QE4 depending on the state of the economy. We also note that the RBA may need to increase the size of its bond purchases given that history shows it is very difficult to achieve low unemployment, particularly when easier monetary policy abroad is placing upward pressure on the Australian dollar.
Nothing I disagree with there but will only make the point that this all hinges on no restoration of the wage-crushing mass immigration regime of the Morrison Government. If that does not return then we will see stronger wage growth and inflation and the RBA’s will need to reverse out of its collapsing NAIRU.
If it does return then the NAIRU will keep on collapsing as underemployment quietly destroys the pricing power of workers and the RBA will never reach any of its targets amid a permanent labour supply shock.