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.