The RBA at today's meeting elected to call time on its 3-year government bond yield target, removing one of the emergency measures implemented by the Board at the outset of the pandemic. An expected strong rebound in the economy from the recent Delta lockdowns and rising inflation pressures have led the Board to move away from its previous 2024 guidance on rate hikes, switching to a more data-dependent focus going forward. However, the RBA's revised forecasts have pushed back against aggressive market pricing, not signalling a rate rise until well into 2023. The cash rate was left at 0.1% and QE purchases will continue at the $4bn weekly pace.
Strong rebound: Higher inflation
In today's decision statement, Governor Philip Lowe outlined the key changes to the Bank's economic outlook. Overall, the revised outlook was less robust than I had anticipated in my preview, but the main themes were the same: the economy is expected to rebound strongly from the recent lockdowns and inflation pressures are rising. GDP growth in 2021 was lowered to 3% from 4% previously, reflecting a larger hit to activity from the Q3 lockdowns than the Bank had earlier forecast. However, the high rate of vaccination and eased restrictions has boosted GDP for 2022 from 4¼% to 5½%, with this rebound cycled into growth at an around trend pace in 2023 (2½%). Unemployment remains on the same downward trajectory anticipated in August, falling to 4¼% next year and then to 4% in 2023.
The key shift from the RBA has come in its inflation outlook, prompted by the upside surprise in Q3's CPI data. Higher fuel prices, the surge in residential construction costs, and the effects of the global supply chain constraints are seen lifting trimmed mean inflation to 2¼% in 2021 (up from 1¾%) and being sustained at that pace through 2022 (from 1¾%). It then firms a little further to 2½% by the end of 2023, hitting the midpoint of the target band earlier than forecast in August. The expectation is that upward pressure on wages will continue to be a gradual process. Wages growth in 2022 was left at a 2½% pace, though there was a slight upgrade in 2023 to 3% (from 2¾%), the level the Bank has said is required to meet the inflation target.
Yield target removed: Forward guidance shifts to a more state-based focus
The decision to end the 3-year yield target policy is an effective validation of the repricing seen at the front end of yield curves across the globe. With markets bringing forward rate hike expectations, Governor Lowe said in his post-meeting press conference that holding the 3-year government bond rate at 0.1% in support of its forward guidance to keep rates unchanged through 2024 was no longer credible.
Accordingly, the removal of the yield target has prompted a shift in forward guidance. Previously, in addition to achieving its employment and inflation objectives, the Board had said that a rate hike was not expected "before 2024". But there is now no specific timing attached to when the cash rate is expected to rise, leaving the data to dictate the timeline. The conditions needed for a rate hike are: "...actual inflation... sustainably within the 2 to 3 per cent target range" together with a "...labour market... tight enough to generate wages growth that is materially higher than it is currently".
In a pushback to market pricing, the statement goes on to say that "The Board is prepared to be patient..." in achieving its objectives. And then the Governor validates this by noting that its inflation forecast is "...no higher than 2½ per cent at the end of 2023" and is accompanied by gradually rising wages. Overall, the revisions to the forecasts point to a rate rise occurring sometime in 2023, likely in the second half. But if there was any doubt, Governor Lowe said in the post-meeting press conference that the new outlook does "...not warrant an increase in the cash rate in 2022".
QE continues
The commitment to maintaining QE purchases at the $4bn weekly pace through February next year was reaffirmed. It was also noted that these purchases will now include the April 2024 bond, which was the target bond for the yield target, though it already holds 63.5% of this line. QE will next be reviewed in February. Tapering has been made contingent on an assessment of progress towards the Board's employment and inflation objectives, the moves taken by other central banks, and overall bond market functioning.
