RBA holds; bring on Lowe-flation

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Against my expectations, the RBA left their policy rate at 1.5% today. 

My main lesson from all this is that Gov Lowe doesn’t care much for his 2.5% inflation target. How else can we interpret leaving policy on hold with inflation below target and the unemployment rate going sideways above the NAIRU – at the same time as they acknowledge that a lower unemployment rate is needed to hit their inflation target?

The only other interpretation is that the politics of the situation got to them.

The decision was clearly a surprise to me – but the set of forecasts that accompany the decision are more-so.  They also happen to align with the budget forecasts delivered by the Australian Treasury in early April.  This is probably no coincidence; and is surely a lesson for me.

The prior weakness in housing and consumption has had most forecasters marking down their growth numbers — but I suppose that’s a problem for the RBA’s August meeting.  The RBA trimmed only 25bps from their Dec’19 GDP forecast (to 2.75%) and left their Dec’20 GDP forecast unchanged at 2.75%.  They’ll be lucky if growth is so strong. Today’s 10bps decline of real retail spending for Q1 (the third weak print in a row) suggests that the forces depressing H2’18 have carried over to H1’19.

With growth expected to hold around trend (and leaning heavily on the still-robust ABS Vacancy measure) the RBA expects the unemployment rate to remain ~5%.  It seems like they have pushed the dip below 5% back to 2021 (Q4’20 was 4.75% in the Feb SOMP), but you can’t be 100% sure from the words in the short statement.

They also appear to have downgraded the NAIRU, acknowledging that there remains slack in the economy and that a 5% unemployment rate isn’t going to get inflation back up to their 2.5% target.

With growth at trend and the unemployment rate going sideways above the NAIRU, I don’t see why inflation is forecast to pick up – but they reckon it will. The RBA expect core inflation to be ~1.75% in Q4’19 (down from 2%) and 2% in 2020 (down from 2.25% in the Feb SOMP table … but actually it was more like 2.125% in the fan-chart). We’re trapped in Lowe-flation: CPI is never going back to 2.5%

The final paragraph says that the board will be “paying close attention to developments in the labour market at its upcoming meetings”, which seems designed to make every meeting live. Still, non-SOMP moves are unusual, and the measurement errors on the household labour force survey are HUGE — so if I had these forecasts I’d really want to see the quarter-average unemployment rate trend up to be sure that something’s going on.

The tragedy of this is that if the RBA waits too long to cut the cash rate, the trouble in the housing market will make rate cuts totally ineffective. Missing the chance to cut with a positive message (we cut because we want faster growth, and low inflation means we can have it) increases the risk that the RBA will be (even further) behind the curve when they do get around to easing.

This increases the possibility of an ultra-low cash rate and quantitative easing down the track. In my view, that’s bad risk management.


  1. The more I think about this, the more devastating I think it is for Lowe’s reputation.

    The final para says, “a further improvement in the labour market was likely to be needed for inflation to be consistent with the target”, and accordingly, “the Board will be paying close attention to developments in the labour market at its upcoming meetings”. But as you indicate, earlier in the statement the RBA predicts that the unemployment rate will be flat at 5% for 12 months. So the RBA will pay close attention to a variable that needs to fall (rather than trend upwards as before – the onus has switched) even though they are not expecting it to improve for at least 12 months! Logic then suggests that they should cut now.

    If the RBA had cut today, Lowe would have looked like a goose for resiling on the rising trend unemployment threshold the month after setting it. I banked on him not wanting to look like a goose. But the low CPI print has evidently made his position extremely difficult. The final paragraph now looks like a cobbled-together compromise designed to keep the internal doves at bay (which may now include – god forbid – the external board members) while he bides his time to cut in a slightly more dignified manner. But the result, as noted above, is a nonsensical mess.

    It’s devastating because it’s happening at the worst possible time for Lowe: an election followed by a likely change of government. Bowen has spoken before in favour of the importance of financial stability (https://www.chrisbowen.net/transcriptsspeeches/the-case-for-financial-stability/), but it’s hard to know whether this was just a political statement designed to provide cover for Labor’s negative gearing and CGT changes or if Bowen genuinely means it. But either way, just at the time when the RBA will need to sign up to a new agreement with a new government, the RBA has undershot its inflation target for several years and has again refused to cut. If the new Treasurer were to downgrade the role of financial stability as an RBA objective in frustration, Lowe will be utterly humiliated. Given his stubborn attachment to the anti-leverage philosophy he has demonstrated to date, it will take a real effort for him to carry on in the role.

    Meanwhile, the rest of the professional – who are piling on today – are not blameless either. They all subscribe (and I include Richard Holden’s piece in the AFR) to the flawed Phillips Curve-based understanding of what drives inflation. Inflation and nominal wages growth across developed countries is low because nominal GDP growth is slow, not because unemployment has not yet fallen to some magic number, nor because of ‘structural factor’s such as global competition and technology, etc. Spare me – we had higher inflation in the 1980s despite massive falls in tariff barriers, simply because nominal demand was rising much faster. Holden’s piece refers to Larry Summers’ support for moving to a nominal GDP target. Well, bravo! The Fed’s James Bullard raised this more recently: https://www.stlouisfed.org/from-the-president/speeches-and-presentations/2019/nominal-gdp-targeting-as-optimal-monetary-policy

    As Samantha said to Smith in Sex and the City, “First the gays, then the girls, then the industry.”

    1. Hey Rajat. Thanks for the thoughtful comment. I agree that ngdp is meaningful—but for Australia we need to strip out the ‘offshore’ mining economy. The rot is even deeper today: this opens them up to criticism for being political.

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