RBA Board Minutes and Governor's Speech
The RBA Board Minutes for June emphasise that the decision to tighten by 50 basis points in June was driven by an upward revision to inflation and the “ highly stimulatory” rate setting. The size and timing of future rate increases will be dictated by the incoming data and the outlook. Policy is still highly stimulatory and a 50 basis point increase in July seems highly likely.”
Today we received the Minutes from the RBA’s June Board meeting, which were preceded by a speech from the Governor to the American Chamber of Commerce.
Both events signalled clearly that the RBA can be expected to continue raising the cash rate, highlighting the key issue that “the level of interest rates was still very low for an economy with a tight labour market and facing a period of higher inflation” (the Minutes).
The Minutes noted hat even if the cash rate was increased by 50 basis points at the June meeting it would still leave the cash rate below 1 per cent, “which would still be highly stimulatory”.
In making the case for a large increase at the June Board meeting (we opted for 40 basis points rather than 50) we made the key point that the RBA focuses largely on the “level” of rates rather than the change in rates particularly when the level of rates is easily assessed as stimulatory.
The case for 50 basis points was therefore logical once the Board focussed on the level of rates.
In the speech today the Governor also noted that “on the basis of the additional information suggesting a further upward revision to an already high inflation forecast.” The Board opted for the 50 basis point move.
This point also emphasises that decisions can be based on any major change in forecasts that can be made privately to the Board at any meeting. Those forecasts can also include themes from the Board’s extensive liaison activities.
Arguably, the 50 basis point decision would still have been taken without the “last minute” uplift in the inflation forecast. (last week the Governor announced in a TV interview that the headline inflation forecast for year end had been uplifted from 5.9% to 7.0%).
The only slight cause for concern around adopting a larger change than had been expected by the media and most analysts was, “whether a 50 basis point move could add to the community’s concerns that inflation was likely to stay high. While this was a risk, the Bank could communicate that inflation was expected to return to the target over time…”
However, the Board did discuss the possibility of a 25 basis point move, “a sequence of 25 basis point moves represented a steady approach to withdrawing monetary policy stimulus and that this was appropriate in an uncertain environment.”
A sequence of 25 basis pint moves to the end of the year would have the cash rate at 2.1% by year’s end;- quite a rapid tightening in an historical context ; other central banks that met less regularly than RBA were moving in 50 basis point increments; and the previous instance of the Board having increased the cash rate by 50 basis points was in February 2000.
There are a number of points to take out of that discussion on the decision.
From my perspective the first is that when rates are “highly stimulatory” the “uncertainty” advantage of smaller increments is not relevant. Uncertainty becomes an issue when rates are higher and it is not clear whether the policy stance is still stimulatory.
The second is that the Bank clearly sees the current situation as probably unprecedented – with labour market tightness; rising inflation; strong demand; and aggressive actions by other central banks. Consequently, the historical precedents are not really relevant.
The third is, arguably, that the Bank is not convinced that a cash rate of 2.1% is necessarily the appropriate terminal rate.
However, this line of argument can go too far. In the Q and A session today the Governor was asked whether there was a possibility of a 75 basis point move at the upcoming meeting in July. The Governor pointed out that in the Minutes which were still to be published that the decision in June was between 25 basis points and 50 basis points. He indicated that the same two options would be addressed at the July meeting – ruling out the 75 basis point option.
He was also cautiously dismissive of market pricing which he interprets as indicating 50 basis points at five of the six remaining meetings this year with the other meeting being for 75 basis points. However, he did qualify that observation, pointing out the market’s recent superior track record on the rate outlook.
In judging how the rate profile might evolve from here the Minutes concluded, “The size and timing of future interest rate increases will continue to be guided by the incoming data and the Board’s assessment of the outlook for inflation and the labour market, including the risks to the outlook.”
Apart from the monthly updates on the state of a very strong labour market and the quarterly updates on inflation other issues that were singled out in both the Minutes and the speech were consumer spending and inflationary expectations.
It was implied that the Board would be sensitive to the profile for consumer spending with housing activity and consumer durables being the most interest rate sensitive parts of the economy.
While emphasising the importance of the $250 billion in excess savings that households have accummulated he acknowledged that “averages” can often be misleading – average interest rate buffer has increased to 21 months my number) but 25% of borrowers still only have a three month buffer (my number) so it will be important to assess the impact of higher rates on the marginal borrowers as well as any “average” concept.
He is also very mindful of the importance of containing inflationary expectations. According to the Bank’s measures expectations are still consistent with inflation returning to the 2-3% band in the medium term. In the Minutes, “Measures of long term inflation expectations remained in the 2-3% target band, although members noted there was a risk that a sustained period of higher inflation could result in a shift up in expectations of inflation.” – the most prominent source of uncertainty was future wage outcomes.
These long term measures of inflationary expectations are derived from the financial markets.
Short term inflationary expectations as measured in the Melbourne Institute survey are showing a sharp lift with the most recent survey for the one year outlook for consumers up to nearly 6% and trade unions up to 4.5%.
Conclusion
By assessing the level of rates as being “highly stimulatory” the decision to lift rates by 50 basis points in June was clearly explained.
The option of moving in regular 25 basis point moves had the advantage of withdrawing the stimulus in regular steps at a time of considerable uncertainty.
If, as we expect, the Board decides to raise the cash by a further 50 basis points in July, the cash rate will still be only 1.35% and still just in the “stimulatory” zone making the “50 in July” a relatively straight forward decision.
We expect that neutral is in the range of 1.5%–2.0%.
As rates go higher so the case that policy is stimulatory becomes less clear and a shift back to the 25 basis point approach seems preferable, although the “every meeting” model which was discussed at the June Board would need to be reviewed given the higher starting point.
Indeed, it is interesting in the Minutes that despite the clear case for moving by 50 basis points the Board concludes that “Given the current inflation pressures in the economy and the still very low level of interest rates, ON BALANCE, (my emphasis), members agreed to a 50 basis point adjustment in the cash rate target.”
If there was some serious consideration given to the 25 basis point move in June then a switch back to 25’s from a higher base seems reasonable.
Our view is 50 in July; 25 in August; pauses in September/October; 25’s in November; December; February for a peak terminal of 2.35%.
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