Today's RBA meeting comes at the start of an important week for Australia's central bank that also includes Governor Philip Lowe's 'Year Ahead' speech tomorrow and the quarterly Statement on Monetary Policy and updated set of economic forecasts on Friday. With the labour market tightening more rapidly than expected and underlying inflation at target for the first time since 2014, the Board is likely to confirm the end of QE purchases today. The cash rate will remain at 0.1% but the RBA may open the door to hiking in 2022, well ahead of recent guidance, should wages growth accelerate. This preview covers the key aspects of today's meeting (decision due at 2:30PM AEDT).
QE Program
The RBA turned to quantitative easing (QE) for the first time in November 2020 to provide additional monetary stimulus to the economy as it was recovering from the pandemic recession. Nearly $275bn of Commonwealth and state and territory government bonds have been purchased under the program; separately an additional $80bn of purchases were made in support of the now-discontinued 3-year yield target. With Australia's unemployment rate now at its lowest level since 2008 and with underlying inflation at the midpoint of the RBA's 2-3% target band for the first time in 7 years, the time has come for QE to be put back in the toolkit.
Since tapering the pace of weekly QE purchases from $5bn to $4bn last September, the RBA has stated that it will be reviewing the program at the February meeting. In his final speech for 2021, Governor Lowe outlined that the Board held a preliminary discussion at the December meeting over its options for the program. Its options included: i) tapering further and ending QE in May, ii) tapering but extending QE beyond May, and iii) discontinuing QE in February. At that stage, the RBA said its economic forecasts were consistent with the first option.
However, discontinuing QE purchases is likely to be announced today given the faster-than-expected progress achieved in the labour market and inflation during the RBA's summer break. Continuing QE to May would rely on the RBA wanting to wait for uncertainty around Omicron to settle, but as was the case during the Delta wave the current disruptions will likely be seen as temporary. Also factoring into the decision will be that many other central banks have either wound up net purchases (BoE, RBNZ, BoC) or have communicated their exit schedules from QE (Fed and ECB). A February finish to RBA QE is consistent with that global shift.
Economic Forecasts
Before his 'Year Ahead' speech tomorrow (12:30PM AEDT) and Friday's quarterly Statement on Monetary Policy (11:30PM AEDT), Governor Lowe is likely to give an outline of the RBA's updated 'central scenario' for the economic outlook in today's decision statement. From a policy perspective, the forecasts for inflation, unemployment and wages growth are the most influential and these are all in line to be upgraded, albeit with there to be an emphasis of uncertainty around these expected outcomes. An assessment of the impact of the Omicron wave on Q1 GDP growth will also be of interest.
Recent outturns have shown a significantly lower unemployment rate and higher inflation than the RBA forecast in November. The unemployment rate fell to a 13-year low in December at 4.2%—a level not projected to be reached until the end of 2022—while annual trimmed mean inflation was 2.6% in Q4 compared to a forecast for 2.5% by the end of 2023. This is likely to bring about an uplift to the forecast path for wages growth, with the timing for the key 3% level the RBA has said is needed to sustain inflation inside the 2-3% target band expected to be brought forward from Q4 2023.
The main uncertainties for the RBA will be how persistent Australia's inflation pressures are likely to be given that many of the drivers are related to the pandemic, while in the labour market the question of how wages will respond to a historically low unemployment rate is unclear. Having been frustrated by slow wages growth over recent years, the RBA has stressed the importance of policy reacting to actual rather than forecast outcomes. With the next update on the Wage Price Index not due until late February, the RBA may be cautious in its outlook.
Policy Outlook
The RBA moved away from date-based forward guidance for 2024 rate hikes when it removed its 3-year yield target in November. The revised economic forecasts that followed that meeting supported a late 2023 or early 2024 timeline for the first hike. But with this week being about recalibrating the messaging on policy to an upgraded outlook for lower unemployment and higher inflation, positioning the stance to respond to the potential for faster wage and price dynamics is likely to see the RBA leaving its options open to hiking much sooner. Whereas late last year Governor Lowe was pushing back on the possibility of hiking in 2022, the messaging seems likely to soften here.
With QE purchases set to come to an end, the focus will turn to the process of quantitative tightening. While other central banks are now discussing how they will reduce the size of their balance sheets, the RBA might have time on its side. The first significant tranche of maturing bond holdings does not come up until July, though in any case the unwind of the balance sheet is much more a 2023 story as that is when banks will start repaying the funding they drew down from the RBA's Term Funding Facility.
Much is expected from the RBA this week considering that markets are aggressively priced for up to 4 rate hikes to be delivered in 2022. However, I think the main messages the RBA will want to get across is that it remains data dependent and that it is now appropriate to have adequate flexibility in the policy stance to respond to the potential for higher inflation. Following the removal of the 3-year yield target and likely end of QE purchases, the RBA is taking another step towards pulling back from pandemic emergency settings.