What a difference a month can make. At the conclusion of the RBA's October meeting, policy appeared set to chart a steady course over the summer as states reopened from extended lockdowns and as the recovery got back on track. But with global inflation concerns mounting, markets have issued a stern challenge to the lengthy timelines for rate hikes put forward by central banks. In what shapes as an important juncture, the RBA gets its chance today to reset expectations, while the Federal Reserve and Bank of England will get theirs later on this week. The writing appears to be on the wall for the RBA's 2024 rate hike guidance and associated yield target policy after last week's severe repricing in the bond market, but a revised set of economic forecasts may be used to signal back to the markets that policy tightening expectations are overdone.
For today's meeting (decision due at 2:30PM AEDT) interest rates (0.1%) and QE ($4bn per week) are likely to remain unchanged, but there could be changes to the tools the RBA will use and to its forward guidance for rate hikes.
Economic Forecasts
The RBA will publish its revised economic forecasts this week, and while they won't be available until Friday's quarterly Statement on Monetary Policy, they will be in front of the Board today. My expectation is for those forecasts to be upgraded significantly, broadly in line with the 'upside scenario' presented in August's quarterly statement.
Growth for 2021 will be lowered sharply, from 4% to around 1%, to incorporate a much more significant hit from the Delta lockdowns than the 1% contraction for Q3 previously expected. But very elevated vaccination rates and a faster easing of restrictions will boost growth in 2022 from 4¼% to something with a 6 in front of it, to be followed by growth at around trend in 2023.
Despite some near-term upward pressure, the stronger growth profile will speed up progress in lowering spare capacity. August's upside scenario has unemployment falling to 3.5% by the end of 2023. A tighter labour market will encourage a faster pace of wages growth, potentially rising to the key 3% pace by the end of next year.
Following last week's Q3 CPI data, inflation is already running ahead of the Bank's forecasts for 2021, while the stronger outlook for growth, employment and wages in 2022 and 2023 adds upward pressure through this key window for policy determinations. August's upside scenario has trimmed mean inflation hitting the midpoint of the 2-3% target sometime in 2023, rising to 2¾% by the end of that year.
Policy Options
A baseline outlook that is broadly consistent with the above is likely to be suggesting to the Board that its employment and inflation objectives will be met by around mid-2023. By that stage, the unemployment rate will be close to estimates of full employment at around 4%; trimmed mean inflation will be around the middle of the target band; and crucially, wages growth will be around the 3% pace the RBA assesses as required to keep inflation running between 2-3%. In this context, the 3 policy options I see as most likely to be announced at today's meeting are discussed;
- Option 1: Remove the 3-year AGS yield target: If the RBA's forecasts point to a rate hike earlier than its current 2024 guidance, then the yield target policy (focusing on the April 2024 bond) can be removed.
- Option 2: Shift the 3-year AGS yield target forward: A variation on option 1. Forward guidance is recalibrated to the outlook as above, but it is backed by the yield target moving to an earlier maturity, the April 2023 line.
- Option 3: Retain the existing 3-year AGS yield target: If the revised outlook turns out not to be as robust as that discussed above, it is possible the RBA will retain its 2024 guidance and associated yield target. The RBA owns 63.5% of the $32.9bn April 2024 line, so there remains scope for further purchases in support of the 0.1% target.
My expectation is along the lines of option 1, where the Board formally removes the 3-year yield target policy in response to an economic outlook that is consistent with rates starting to rise earlier than the current 2024 guidance. The decision not to defend the 0.1% target last week suggests that the policy may have run its course. But in this scenario, the Board may elect to tweak its forward guidance, to more of a state-based rather than a date-based approach. The revised forecasts would then signal to markets that rate hike pricing has moved too aggressively. With a focus on actual outcomes, a rate hike could be made conditional on inflation being confirmed at (or close to) the target and then forecast to remain or to be rising from there. This would need to be underpinned by wages growth running at 3% (or close to it), generated by a labour market assessed at full employment.
QE Tapering
Back in September, the RBA stuck with its earlier call to taper the weekly pace of QE purchases from $5bn to $4bn, but it delayed the timing of the next review of the program from mid-November to mid-February 2022. This was about removing the risk of expectations for another taper building at a time when the economy would be recovering from the Delta lockdowns. Through its various communications this week, the RBA may choose to provide some clarity around the tapering timeline beyond February and the conditions needed for that to occur.