Monetary Policy Pulse
On the economic front 2021 has thrown out a number of surprises. During the first half of the year economic recovery in Australia was stronger and faster than widely expected. The unemployment rate fell more than expected. Robust growth in demand and restricted supply of goods and services caused a bigger inflation blip than expected. Now the Delta outbreak, with its associated restrictions, is set to cause a fall in Australian demand and GDP growth in Q3 plus heightened uncertainty about the outlook beyond Q3 depending upon what highly vaccinated “new normal” freedom and economic activity looks like.
Despite the swings in economic fortune this year so far, the RBA has kept monetary policy settings largely unchanged. In its own words, it is “committed to maintaining highly supportive monetary conditions to achieve a return to full employment in Australia and inflation consistent with the target”. What changes there have been to monetary policy are the smallest of tweaks and only to the non-interest rate part of the policy setting.
The latest tweak occurred at the September Board meeting last week and was really just a follow through on what the Board announced the month before, a reduction in the RBA’s weekly bond purchase program to $4 billion a week from $5 billion a week starting in September. The only reason the announcement seemed like a change in policy was that evidence of the near-term damage to the economy from the Delta outbreak proliferated between the August and September RBA Board meetings creating market expectation that the RBA might backtrack on its decision to start tapering its bond buying.
The reduction in the weekly bond buying program means little in the monetary policy scheme of things. The RBA is not expecting to follow up with further reductions near-term. It stated that purchases at the rate of $4 billion a month will continue to at least mid-February 2022. Also, the bond purchases running at an annual pace above $200 billion are higher than the Government’s forecast 2020-21 budget deficit $107 billion (even if running materially higher because of Delta) and may continue to keep short-term 2 and 3-year government bond yields running close to zero per cent, not even the 0.10% 3-year bond yield target.
Concerning interest rates, the RBA’s position is unchanged. The official cash rate target remains 0.10% and the interest rate on Exchange Settlement balances remains zero. The target interest rate on the 3-year government bond (April 2024 maturity) remains 0.10%. As the RBA has said repeatedly this year the cash rate will not increase “until actual inflation is sustainably within the 2 to 3 per cent target range”. The RBA’s “central scenario for the economy is that this condition will not be met before 2024. Meeting this condition will require the labour market be tight enough to generate wages growth that is materially higher than it is currently”.
It is worth keeping in mind that the RBA’s central scenario forecasts are comparatively optimistic. They show only temporary Delta disruption to the economic expansion in Q3. In their words, “The Delta outbreak is expected to delay, but not derail, the recovery”. Later in the September Statement by Governor, Philip Lowe, “In our central scenario, the economy will be growing again in Q4 and is expected to be back around its pre-Delta path in the second half of next year”.
There is recognition that the timing and pacing of the bounce-back in the economy is uncertain depending on the health situation and easing of restrictions. If anything, this uncertainty may add to delay before the RBA makes any policy change.
The key reason, however, why any lift in official interest rates is a long way off is that the labour market is still far from tight enough to generate annual wages growth consistently above 3% y-o-y. The latest reading of annual wages growth for Q2 2021 was only 1.7% y-o-y and that at a time when employment growth was very strong and the unemployment rate had fallen below 5%.
The Delta outbreak has intervened and will push employment growth into reverse temporarily (the August labour force report out on Thursday is expected to show employment down 70,000 at least). The unemployment rate will be higher for the next few months as well. Wages growth may falter too. Annual wages growth will more certainly stay weak extending through 2022 and possibly 2023.
While wages growth remains weak the RBA will welcome any upside surprises to its economic growth forecasts as helping the economy move towards full-employment. The RBA will also read through high inflation readings related to supply of goods and services undershooting strong demand as the price pressure will be self-correcting unless ratified by higher wages.
The monetary policy pulse only starts to race these days when the RBA sees inflation in the rear vision mirror. It is a different world from the past three decades when the RBA would increase rates ahead of a forecast lift in inflation. Lifting interest rates in reaction to labour market tightness and a consistent rise in inflation (both lagging indicators of economic activity) means interuption of long-term disinflationary forces and economic cycles where each cycle peak in interest rates is lower than the previous cycle peak. Instead, the risk is higher inflation and rising interest rates longer term.
But that is the longer-term risk for 2024 or later. Over the remainder of 2021, 2022 and 2023 monetary policy dial remains set at very growth accommodating with the official cash rate no higher than 0.10%.