- The RBA has acknowledged the current weakness in the economy;
- They remain positive about the outlook for the next couple of years;
- Albeit there is more risk to the outlook than they had previously thought;
- The RBA would still be comfortable with their view that interest rates will not rise until H1 2024;
- The risks are that the cash rate might need to rise a little earlier (H2 2023);
- It is hard to prove but QE does help the economy.
Heading into the September meeting the economy in Q3 had weakened substantially more than RBA forecasts had predicted in August. The Statement following the meeting rightly highlighted the considerable momentum the economy had entering the September quarter. It also acknowledged that the economy has subsequently weakened significantly. Their central-case view is that the pause in economic growth will only be temporary (in RBA words, the recovery is delayed not derailed). The recent data also provides some comfort about the medium-term. But the risks to the outlook have increased.
The RBA Statement did not say much on the supply-side of the economy. Understandably given the most immediate economic problem is the impact of the Lockdowns. Previously the RBA has said that it thought that any supply problem (supply-chains problems, skilled labour shortages) would be a short-term worry as economies re-open. But the evidence suggests that a return to full re-opening will take longer than had been anticipated. This creates some demand headaches for the economy. But it also means that supply problems may last longer.
Recent developments would have provided some sustenance to the RBA view that the cash rate would not need to change until the first half of 2024. Financial market economists (including me) believe that the RBA will need to move a little earlier, with the consensus expecting a first rate hike in late 2023. That may reflect a little more optimism about the economic outlook than the RBA. But in my case at least it is the thought that the supply problems will last longer. And this means a greater risk of higher inflation and wages growth than the RBA’s current view.
At the time of writing, financial markets are pricing the first rate hike by the end of 2022 with a cash rate of about 0.75% by the time the RBA is thinking about first changing the cash rate (H1 2024). This pricing has the RBA moving at around the same time as the Federal Reserve. At face value this looks a little strange.
Prior to the September meeting there was discussion that the sharp contraction in economic activity would lead the RBA to revert back to its previous pace of weekly buying ($5b) but keep the review date (November). In the event the RBA announced that it would keep the pace of buying at $4b but delay the review until February 2022.
The RBA did not explain why it chose to maintain the slower pace of buying. Most probably it was a vote of confidence in an economic pickup next year. There may have been recognition than most other central banks are looking to slow their bond buying programs. It could be that by delaying the time for review until February the amount of bonds that the RBA is buying would be broadly the same under both options.
Right now the most important issue for the economy is the health outlook. If the medium-term economic outlook is worse than expected fiscal policy should (and almost certainly would) step up. By keeping interest rates as low as possible and ensuring that (sustainable) financing is widely accessible the RBA is doing what it can to help the economic recovery. Undertaking QE provides confidence to investors’ that the RBA will do what it can to improve the economic outlook. In turn that makes it more likely that an economic recovery will take place.
To read my full update, click here.
We live in interesting times.
Peter Munckton - Chief Economist