The RBA Board has responded to Australia's rapidly tightening labour market and higher-than-expected inflation by announcing the end of the purchase phase in its QE program at today's meeting, while the cash rate target was left unchanged at 0.1%. Uncertainty around the evolution of wage-price dynamics means the Board is leaving its options open in 2022, though there was some subtle push back against the aggressive rate hike expectations in markets.
As was widely expected, today's decision statement from RBA Governor Philip Lowe confirmed that QE purchases will be discontinued. Following a long-awaited review of the program, Governor Lowe cited the faster-than-forecast progress achieved in the Australian economy towards the Board's full employment and inflation objectives and the actions of other central banks in moving away from QE as the factors behind today's decision. By the time the final purchases are made on February 10, more than $277bn of Australian and state and territory government bonds will have been added to the RBA's balance sheet since its inception back in November 2020. Around $80bn of purchases were made in support of the 3-year yield target before it was discontinued late last year. While other central banks are now moving towards reducing the size of their balance sheets, in my preview I discussed the reasons why the RBA has time on its side here. Indeed, Governor Lowe confirmed today that the decision around whether it plans to reinvest maturing bond holdings or allow maturing bonds to roll off its balance sheet has been delayed until the May meeting.
In terms of the economic outlook, the unemployment and inflation forecasts have been upgraded to reflect recent progress. The unemployment rate is now seen falling south of 4% this year before declining to 3¾% by the end of 2023, the latter marked down from 4% previously. Such a decline would be a historically low unemployment rate for Australia, and the RBA is uncertain how wages growth will respond in that scenario. This will ultimately be key to the inflation outlook. However, for now, the RBA has had to revise sharply higher its inflation forecasts on the back of the Q4 data. Underlying inflation is now seen peaking as high as 3¼% before easing back to 2¾% in 2023 as the pandemic dissipates and supply constraints are resolved. In the November forecasts, underlying inflation was anticipated to gradually lift from 2¼% to the middle of the 2-3% target by the end of next year.
Meanwhile, the GDP growth outlook has been revised lower. The 2022 'year-average' forecast was reduced from 5% to 4¼% in response to the effects of the Omicron wave, but the outlook in 2023 was also cut from 3% to 2%. I'd argue the reduction in the latter is push back against the aggressive pricing in markets for 4 rate hikes this year. The Bank uses the market curve for the cash rate as an input in its economic forecasts. A forecast slowing in growth from 4¼% to 2% in 2023, a pace below estimates of trend growth, reflects the effect of higher rates on activity and hardly seems a desirable situation.
Today's final paragraph set the scene for Governor Lowe's 'Year Ahead' speech tomorrow and the full set of economic forecasts in Friday's quarterly statement. The RBA is very much in a data-dependent mode and has said it will be patient as the wage and inflation dynamics evolve before determining if a response is warranted. The ending of QE purchases gives the RBA optionality to respond to the upside risks, but the aggressive hiking cycle forecast by markets doesn't appear to be supported in today's statement.
