Reserve Bank of Australia board meeting commentary

From

Stephen Miller

The RBA Board meeting on Tuesday is unlikely to elicit much by way of policy announcements or even changes to the policy roadmap. That will come at the next meeting in February when a decision on quantitative easing (QE) will need to be made. 

However, unlike most other developed countries, Australia has not had an update on the inflation picture since the end of September. It is more than a little embarrassing that Australia stands out as one of the only countries in the developed world that does not have a monthly consumer price index (CPI), not the least because it robs the policy authorities of timely updates on economic circumstances highly germane to policy-framing. 

Yet, the RBA does have some thinking to do even if the RBA’s favoured trimmed mean measure of inflation is at the lower end of the RBA’s 2-3 per cent range and the most recent wage price index measure remains modest at 2.2 per cent.

Certainly, RBA communication might be better nuanced to place some emphasis on the inherent uncertainties attaching to the economic outlook and attendant monetary settings. 

It is a fact that central banks (like markets) are imperfect forecasters of their own actions. That is more apposite than usual in the current highly uncertain environment as economies emerge from the dislocations wrought by the pandemic. 

By failing to acknowledge that uncertainty, the RBA has become trapped in a “central scenario” that appears to be at one end of the inflation risk continuum.

In so doing, the RBA risks denying itself the requisite ‘wiggle-room’ should circumstances turn out different to its forecast. The continued confusing conflation of ‘outcomes-based forward guidance’ (OBFG) with calendar guidance is not helpful and probably not necessary.

Australia will not be immune to an ongoing impact from supply disruptions. It isn’t axiomatic that inflation effects that emanate from supply disruptions are “transitory” and nor is it clear that these pressures are exclusively supply driven.

In his Australian Business Economists (ABE) appearance a couple of weeks ago, RBA Governor Philip Lowe firmly embraced the “transitory” inflation rhetoric that a number of other central bank chiefs trotted out in the first half of this year. Now those same central bank chiefs are disengaging from that “transitory” rhetoric because it is either not accurate or not helpful or both. 

Of course, as the Governor suggests, the Australian economy is different from other developed economies (not least in its exposure to China), but not sufficiently so that the same laws of supply and demand and their effect on prices do not apply here. 

Australia is an example of what the textbooks term a ‘small-medium open’ economy. By definition, such economies are ‘price-takers,’ with that ‘price’ determined by global forces. Accelerating global inflation – other things equal – means accelerating Australian inflation. 

Nor were the Governor’s arguments particularly convincing:

  • The Governor cited “increasing globalisation” as keeping a lid on prices. However, the political currents are running the other way with a populist backlash against globalisation of markets seeing increasing protectionism, along with increasingly more activist domestic regulatory agendas. This will lead to heightened upward pressure on business costs and prices. 
  • On the labour market, the Governor made much of so-called “wage inertia.” The thinking appeared to go that the maintenance of a relatively high participation rate, due to measures such as Job-Keeper, means wage growth may be more relatively subdued. It might just as easily be argued that a lower pool of ‘discouraged’ workers in Australia means more proximate wage acceleration here than elsewhere, particularly given the drying up of inward bound migration flows over the last couple of years and ongoing internal restrictions. This may ease, but not quickly.

The notion of “transitory” inflation is that it doesn’t change wage and price setting behaviour. But there is growing evidence that these behaviours are changing: companies feel more confident to increase prices because prices are going up everywhere, while workers are naturally seeking higher wages in those areas of the economy where skill shortages are acute. 

In other words, even if it cannot influence supply levers in the economy, by failing to incorporate supply shocks in its monetary policy framework, central banks can magnify and perpetuate the inflationary damage such shocks can inflict. 

None of this is to suggest that the RBA “central scenario” is implausible. It certainly is not. 

Nor does it suggest that the RBA have not proved themselves in their management of monetary policy during the pandemic, where it has exhibited a noteworthy proficiency. 

But that “central scenario” is one firmly rooted in the downside end of the inflation risk continuum.

It appears that the RBA is still backward looking, perhaps burdened by an ill-timed – even clumsy – embrace of outcomes-based forward guidance which it continues to confusingly conflate with calendar guidance. 

Monetary settings remain close to those consistent with an “emergency” and the RBA creates the impression that it is dismissive of the upside risks that have been starkly revealed elsewhere in the developed country complex. 

By not acknowledging it “doesn’t know what it doesn’t know” and that inflation risks are asymmetrically weighted to the upside, and that, accordingly, policy rate increases may be required earlier, the RBA potentially depreciates the utility of future communication with an attendant weakening in the high regard with which it is currently held in financial markets. 

By Stephen Miller, investment strategist 

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