Stephen Miller
Even before the Sydney COVID-19 outbreak the prospect for any major shift in policy from the Reserve Bank of Australia (RBA) was remote. A cautious US Federal Reserve (the Fed) and the Sydney COVID-19 outbreak mean that any changes announced on 6 July will be very much at the margin only.
That is not a surprise. Even in the face of much stronger than expected labour market outcomes in terms of large increases in employment and an unemployment rate declining much faster than anticipated, the RBA Governor indicated in his most recent comments that he remains of the view that any meaningful acceleration in wages and prices is still some way off.
What is surprising in this context is that markets have brought forward the pricing of an increase in the policy rate now to the end of 2022. While that is plausible, I would say that given what we know now it is unlikely.
The fiscal boost in Australia was way less than that applied in the US and the prospective regulatory agenda less ambitious in the sense that it won’t motivate as big an increase in business costs.
It seems clear, that the RBA’s view is that while inflationary pressures in the US are clear, they are less visible in Australia.
While base effects will see June quarter annual ‘headline’ inflation likely get close to 4 per cent, the RBA’s preferred trimmed mean measure is forecast to be around 1.5 per cent, still well south of the RBA’s 2-3 per cent target. Indeed, the RBA forecasts only have inflation reaching the bottom of the 2-3 per cent inflation target band in June 2023, and even then, wages are forecast to be running at a paltry 2 ¼ per cent.
As part of the quest to generate tight labour markets and attendant wage and price inflation, the RBA remains motivated to avoid an unwelcome upward movement in the Australian dollar (AUD).
Any move up in the AUD could well frustrate the task of getting unemployment down and wage growth and inflation up. It seems clear that the RBA has achieved its stated objective of “keeping the AUD lower than it otherwise would have been”. In my view, it won’t wish to unwind those achievements by “prematurely” foreshadowing a significant retreat from the currently historically high levels of monetary accommodation.
The RBA also appears largely unconcerned by market expectations of inflation rebounding. Like the Fed, that may reflect a belief that any near-term inflation will be essentially transitory. It may also reflect that current market-based expectations of inflation are toward the bottom end of the RBA’s 2-3 per cent target range.
The Board will make a decision on whether the 3-year bond target will roll to the November 2024 bond from the current April 2024. That meeting will also consider future bond purchases following the completion of the second $100 billion of purchases under the government bond purchase program in September.
The Board is unlikely to roll to the November 2024 bond.
Given the RBA’s unequivocal commitment to full employment, and given that despite more rapid progress on the unemployment front, it is still some way north of the 4 per cent or even “3 point something” previously cited by the Governor as getting close to capacity, the RBA would appear to be likely to implement only marginal adjustments to its QE program. Changes to QE appear likely to be implemented “flexibly” and with caution, perhaps by signalling a likely weekly run-rate of purchases say between $2.5b – $4b a week. Initially I would expect that to be at the upper end of that range which is not that different from the current program other than it may be adjusted more flexibly should circumstances warrant.
Such measures are at this stage rather small in the scheme of things given the prevailing expectation of the RBA Board that a policy rate increase is “unlikely to be until 2024 at the earliest.” And despite market pricing that would still be the RBA’s best guess.
For the time being it remains the case that while the economy’s performance has certainly exceeded expectations, recent price and wage growth remains at levels that are still uncomfortably low for the RBA and its inflation objective and, as mentioned, the unemployment rate, again while having bettered expectations, is still some way from a level consistent with full capacity.
While ever that remains, and while ever the Fed remains in no hurry to adjust its settings, and while ever there is no “lived experience” of adequate wage and price inflation, we should expect the maintenance of the historically high accommodatory tack from the RBA even if some (very) marginal retreat from current levels of monetary stimulus is announced in July.
By Stephen Miller, GSFM investment strategist