By Gareth Aird, head of Australian economics at CBA. My view is that the RBA will wait until late in the year (after annual wage growth has risen above 3%) before lifting rates.
Key Points:
- RBA Governor Philip Lowe today sounded closer to raising interest rates than at any other time over the pandemic.
- The RBA Governor made it crystal clear that the RBA do not need to see two further CPI prints before raising the cash rate.
- We continue to see June as the most likely month that the RBA will commence raising the cash rate (the May Board meeting should be considered “live”).
The RBA are not committed to seeing two more CPIs before raising the cash rate
RBA Governor Lowe today delivered a speech at the AFR Business Summit on Recent Economic Developments.
We believe that since the RBA abandoned its yield curve control (YCC) policy following the Q3 21 CPI, released on 27 October, the RBA has sounded closer to raising rates with each new piece of communication. In some respects in has been a slow shift in narrative. But in other ways the RBA have moved a lot in a short period of time.
In October 2021 the RBA was still running with the 2024 mantra and stated their central scenario for the economy is that the condition to raise the cash rate would not be met before 2024. Today RBA Governor Lowe stated in his speech, “it is plausible that the cash rate will be increased later this year” (he made a similar remark in answer to a question a month ago).
The Governor was the architype two-handed economist today. On the one hand he stated that, “the recent lift in inflation has brought us closer to the point where inflation is sustainably in the target range. So too have recent global developments. But we are not yet at that point. In underlying terms, inflation has just reached the midpoint of the target band for the first time in over seven years.” This implies the Governor is still not yet convinced that inflation will not drop back below the target.
But on the other hand the Governor concluded his speech with a hawkish remark; “I want to finish with the point that it is only possible to achieve a sustained period of low unemployment if inflation remains low and stable. Recent developments in Europe have added to the complexities here. The Reserve Bank will respond as needed and do what is necessary to maintain low and stable inflation in Australia.” This is the first reference made by the Governor since the pandemic to the RBA being a potential inflation fighter!
Governor Lowe made reference to the multiple measures of labour costs they are watching: “The second issue we are watching closely is the evolution of domestic labour costs. The latest data confirmed that aggregate wages growth remains modest. The Wage Price Index (WPI) increased by 2.3 per cent last year, with the broader measure including bonuses increasing by 2.8 per cent (Graph 10). The national accounts measure of average hourly earnings increased a bit faster than this at 3.3 per cent.” This creates flexibility to raise the cash rate without being beholden to the WPI printing at a particular level.
Our call
On 15 February 2022 we shifted our central scenario for the RBA to commence normalising the cash rate to June 2022, from August 2022 (see here).
The timing of that shift appeared counterintuitive given on 11 February 2022 the RBA Governor stated “another couple of CPIs would be good to see” when asked if he like to see at least one or two more CPIs before concluding inflation is sustainably within the target range (note that the Q1 22 CPI prints 27 April and Q2 22 CPI prints 27 July).
But we did not interpret the Governor’s desire to see a couple more CPIs as a firm commitment that the Board would not raise the cash rate until they had seen a further two CPIs. Rather we interpreted his statement to mean that the RBA will conclude that inflation is “sustainably within the target range” if the next two inflation prints are in line with their forecasts.
But our expectation is that the upcoming CPI will be a lot stronger than their forecasts which means our call for June rate hike was founded on the idea that it is not necessary to see “a couple more CPIs” provided wages growth continues to accelerate and the labour market further tightens, as we anticipate.
Today the Governor confirmed that our interpretation was correct. The Governor was asked whether it is necessary to see two more CPIs before raising the cash rate. He replied, “we don’t have a plan”. This made it crystal clear that the RBA do not need to see two further inflation prints before raising the cash rate.
This does not mean in and of itself that the RBA will raise the cash rate before August (by which two further CPIs would have printed). But it does mean a rate hike is on the table before August (some commentators have suggested Board meetings before August are not live because the RBA had committed to seeing two CPIs before raising the cash rate).
Overall today’s speech and Q&A session left us very comfortable with our call for the RBA to commence normalising the cash rate in June. We expect the RBA to shift to a hiking bias at the May Board meeting (the May Board meeting should be considered “live”).
We retain our central scenario the RBA takes the cash rate to 1.25% in Q1 23. We anticipate the RBA will leave policy on hold over the rest of 2023 given our expectation that the neutral rate is low and the significant expiry of fixed rate home loans which occurs over 2023 will create a natural tightening over the year.
