RBA Nov’21 SOMP: sets high hurdle for 2023 hike

The RBA used their November SOMP to push back on market pricing for rate hikes. The clear message of the SOMP is that inflation will take some time to be sustainably in the middle of the 2% to 3% target range, wages are low and slow (or subject to a lot of inertia, to be more precise). They used their upside scenario to set the conditions for a hike in 2023: sub 4% unemployment and core inflation headed above 3%.

On the central case, trimmed mean inflation forecast peaks at 2.4% in Q4’23 (the forecast will roll to 2024 in the Feb’22 SOMP), and wages still only barely kiss 3% at that time. Consistent with this, the SOMP says that ‘the Board judges that this outcome could be consistent with the first increase in the cash rate being in 2024.‘ The change to ‘could be consistent’ is a bit weaker than ‘not until 2024’, however it had to be a bit weaker to fit with the dumping of YCC.

The Outlook = mostly about wages

The key thing in the outlook is the inflation forecast. Though it has been upgraded (by ~50bps in 2022 and 25bps in 2023), it still never gets back to the midpoint of the RBA’s 2.5% target. It’s on this basis that the Board were able to say that the first hike might still come in 2024. Core (trimmed mean) inflation simply hangs around the current level until 2023, and then picks up a bit.

You can see this in the quarterly profile, where the RBA has core inflation slowing from the current 0.7%qoq to ~0.5%qoq, before accelerating with wages. My guess is that there was a bit of judgement applied to these forecasts: the seasonality in the qoq rates is typically of forecasts that are made by smoothing the YoY rates.

The RBA went some way to dismissing the high inflation of Q3’21, noting that two-thirds of the inflation came from higher fuel prices and the jump of home-building costs. I am surprised they did this, as alternative measures of inflation, such as the weighted median and trimmed mean, were also high in the quarter (as were measures of inflation’s breadth). I think this tells you a lot about their psychology just now. They are really committed to the wages -> core inflation narrative.

The wages projections have hardly moved at all. If this narrative is going to be upset, I think we’ll need to see a genuine surprise from the WPI releases (or more likely a few of them). The WPI calendar is: 17 Nov; 23 Feb 2022; 18 May 2022 … so it’ll be almost impossible to get H1’22 hikes.

The inflation chapter again ran through the facts on wage freezes and inertia in the Australian labour market. Given institutional arrangements, particularly multi-year wage agreements, it is hard for Australian wages to accelerate quickly in normal times. With about 40% of the labour force still subject to wage-freezes, it seems very unlikely.

Consistent with this, we see a sharp increase in the share of workers receiving pay increase in the 0% to 2% range, and a decrease in the share of workers receiving larger pay increases. Basically everyone is getting 2% or so.

Looking ahead, liaison is telling the RBA that wages will accelerate in 2022. However, the distribution of firm wage-growth expectations is less inflationary than 2019 — with more firms expecting to grant pay rises in the 0% to 2% range, and fewer in the 2% to 3% range. Overall, firms expect a return to 2.5% wages growth.

The magic formula here is that wages, less productivity, equals core inflation. So if wages are growing at 2.5%yoy, you need zero productivity growth to hit the 2.5% inflation target. the long run average is more like 1% — so it follows that it’s very unlikely that we’ll see sustained core inflation of 2.5%yoy with the current state of the wages. You’d like to see 3.5%yoy to be really confident.

The text puts a lot of emphasis on the better-than-expected progress toward the RBA’s goals, however kit’s a fudge. No one wants to tighten due to inflation, so they’re telling a story … but the charts tell the truth.

The truth is that there has been basically no change to the RBA’s GDP forecast for the periods that really matter for monetary policy. The Delta-downturn is a bit bigger (it’s now -2.5%qoq), however so is the bounce, and by H2’22 we are back on the August (and pre-Delta) path.

The Scenarios = it’s all about uncertainty

The SOMP has two scenarios that revolve around uncertainty. The real point of the section, however, is to lay out the hurdle for an early rate hike. The point is that it’s very high.

The upside scenario has the unemployment rate falling below 4% in 2022, and trimmed mean inflation rising above 3% in 2023. In this case, the RBA tells us that they’d begin raising rates in 2023 — NOT 2022.

What’s really unknown right now is the extent to which households will spend the savings and wealth they accumulated in the last two years.

A large increase in housing and equity prices means that they could spend their equity. Similarly, both the stock of savings and the flow (the ‘savings rate’) remain elevated. However, it’s possible that households will remain cautious, keeping the unemployment rate high and inflation low.

I have the sense that the RBA would very much like to get onto the high-consumption path. And their message is: party on! We’re not going to do anything to push the economy off that higher path (at least not until 2023).

The RBA doesn’t want to make another hawkish error

The RBA really doesn’t want to make another hawkish error. I got that strong sense from Gov Lowe’s press conference following the RBA’s 2 November meeting, and you can really see it in the way they pitch these scenarios.

If Australia gets on the high consumption path, the RBA will not do anything pre-emptive to slow consumption growth and limit inflation. They’ll simply allow the unemployment rate to drop below 4% and core inflation to move above 3% in 2023. That’s powerfully dovish.

I think this underlines the RBA’s very strong desire to see record lows for the unemployment rate, and their relatively relaxed stance with regard to a period of above-target inflation following a long period of undershooting. I also think it’s a response to the bi-partisan calls for a review of the RBA. The structural break of inflation around the time Lowe took over as Governor is, at least, inconvenient.

The best defense is hitting their inflation target.

Pushing back the hikes

Given that the RBA is guiding to hikes in 2023 in the case of sub 4% unemployment and above target core inflation, you have to push back your hikes a little. I now think the RBA will firm up the interbank market in H2’23 and hike either late 2023 or early 2024 (I had previously figured they’d firm things up in late 22 and hike in early 2023).

No one can forecast that far out — but when it comes to inflation, history shows that the RBA is the best!

Leave a Comment