The all-important July RBA Board meeting had something for everyone this week, with the first steps towards policy normalisation coming as the expectation for rate hikes to commence earlier than 2024 was reaffirmed as unlikely. Despite the uncertainties associated with the recent virus outbreaks and lockdowns, the resilience of the economy to rebound from similar setbacks throughout the pandemic and the pace of progress seen to date in both employment and output has the RBA sufficiently confident that the transition from recovery to expansion remains on track. This assessment has prompted a recalibration of policy, with the direction now shifting towards tighter rather than easier settings. On this week's decisions, the Board decided not to extend the maturity of the yield target, retaining the target bond at the April 2024 AGS issue, while QE purchases are to be dialed back slightly from early September where the current pace of $5bn per week will ease to $4bn (reviewed here). The non-extension of the yield target had been expected by markets but the decision to signal the start of tapering had been at the more hawkish end of forecasts going into the meeting.
As discussed by Governor Philip Lowe in Tuesday's post-decision press conference, the overall monetary policy stance has been recalibrated to reflect the shift in expectations for the economic outlook. While the Board continues to assess the economy as being unlikely to be in a position where rate hikes can commence earlier than 2024, it also acknowledges there are other possibilities here. This was the basis for not extending the yield target, meaning that instead of rolling over the signal to keep rates at 0.1% for the next 3 years, the commitment gradually declines as we approach April 2024. Key for the RBA remains the outlook for the labour market, with expectations for wages growth still seen as being inconsistent with meeting the inflation target earlier than its 2024 guidance. Going into greater detail in a separate speech, Governor Lowe pointed to the responsiveness of labour supply to meet increases demand as contributing to slow wages growth over recent years. While the onset of the pandemic and travel restrictions have clearly affected one of the channels of labour supply, the RBA had not seen evidence that higher wages in areas where there was a shortage of skills would broaden out across the economy. As such, with a tight labour market remaining its focus, the Board opted to expand QE purchases beyond early September and has committed to keep doing so until it has seen "further material progress" towards its inflation and employment goals. But QE purchases are set to take on a more nuanced approach from current parameters. Firstly, there is to be a reduction in the run rate to $4bn/wk from $5bn, a modest tapering signal (see chart below) reflecting the progress already achieved in the recovery, and secondly, the pace will come under review periodically as the economic conditions evolve. Initially, this course has been committed to from early September through to the November Board meeting, which will result in a further $42bn of purchases on top of the $200bn that will have been completed by that stage.
Chart of the week
To this week's data releases where there was an upwardly revised final estimate for national retail sales, rising by 0.4% for the month of May against a broadly flat (0.1%) preliminary reading (reviewed here). Victoria's recent lockdown induced significant volatility into the result, reflected in the composition of spending growth nationally with strength in food retail (1.1%m/m) offsetting weakness in discretionary categories (-0.1%m/m). Further volatility will come through in June and July reflecting more lockdowns, but retail spending still remains elevated, standing 12.2% above pre-pandemic levels. Dwelling approvals posted a second consecutive sharp monthly fall with a 7.1% decline in May, centered on weakness in the detached segment (-10.3%m/m) that reflected the unwinding effect from the recently expired HomeBuilder grants scheme (reviewed here).
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Moving offshore where reflation trades have continued to come under pressure, with the flattening in yield curves ramping up debate over the catalyst. On the one hand, positioning squeezes and significant central bank purchase programs are put forward, but on the other is the sentiment that growth and inflation expectations have seen their peaks and are now set to decelerate. That debate will roll on, but there was little new information for markets to factor in this week other than the ongoing concerns with the Delta strain and perhaps a shift in perceptions of the recent Federal Reserve meeting. The minutes from the FOMC's June meeting put a slightly different spin on the widely hawkish interpretation taken at first glance. The updated summary of economic projections showed that the median expectation for rates had brought forward two hikes into 2023 but the meeting minutes did not appear to completely vindicate the sense that policy tightening would be hastened. Coming well before any rate hikes will be the tapering of QE purchases from the current pace of $120bn/mth, but the threshold for this to occur has yet to be met and as several of the Committee members noted was still far from doing so. With the "substantial further progress" towards its employment and inflation goals yet to materialise, the patient approach being taken to tapering seems likely to continue. Thus the emphasis is on the data flow over the near term, with next week's CPI inflation report for June the highlight event on next week's calendar.
Over in Europe, the ECB tabled its long running strategy review into the conduct of its monetary policy. The outcome was as had been widely touted in recent weeks with a modification being made to its inflation target from "below, but close to, 2%" to a symmetric 2% target over the medium term. In practical terms, this change is a tilt towards a more dovish structure in that it will permit the Governing Council to tolerate a period of overshoot in inflation, in turn allowing other macroeconomic objectives such as full employment to be prioritised. But it stops short of shifting to the Average Inflation Targeting regime of the Federal Reserve, in which policy is set in such a way to generate overshoots to make up for earlier periods where inflation was too low. As it currently stands, the ECB's projections for inflation sit below target this year (1.9%) and in 2022 (1.5%) and 2023 (1.4%). Also from the ECB this week was the account of the June policy meeting. The consensus among the Governing Council was to continue with purchases under the PEPP program at their accelerated pace over the current quarter to preserve favourable financing conditions over the summer months. However, of interest was the line that some members had argued for the pace of purchases to be tapered to reflect an improved growth and inflation outlook. Surprising to the upside this week was May's reading on euro area retail sales, which came in at 4.6% for the month (vs 4.3% expected) to be up by 9.0% over the year (vs 8.2%). This was driven by a surge in non-food sales volumes (8.8%mth) as the easing of restrictions saw consumer demand rebounding very strongly from a weak result in April.
