In today’s Money Morning…the RBA is wrong…inflation… unemployment…what to watch for…and more…
The Reserve Bank of Australia (RBA) is meeting today to vote on interest rates. They’re widely expected to keep rates on hold.
As I wrote about in a previous Money Morning article, the RBA is at odds with the bond market on their expectations for interest rates this year.
And the RBA is wrong.
I wanted to have a bit of a look into what’s likely to happen at today’s meeting and what’s important to watch out for. This includes the one critical piece of data that could determine how soon they raise interest rates.
But first, we need to understand their actual purpose.
The RBA has three primary goals with regards to monetary policy:
- ‘The stability of the currency of Australia;
- the maintenance of full employment in Australia; and
- the economic prosperity and welfare of the people of Australia.’
These are pretty vague goals, if you ask me. So that’s why we need to dig through meeting minutes and past statements by board members to figure out what they really think is important right now.
Inflation
For starters, they’ve set an actual inflation target:
‘The Governor and the Treasurer have agreed that the appropriate target for monetary policy in Australia is to achieve an inflation rate of 2–3 per cent, on average, over time.’
Inflation has been the global story of the day for the past few months. So what is the RBA thinking about it?
In their December meeting minutes, they reasoned that:
‘An increase in the cash rate in 2022 was not warranted on the basis of the Bank’s central scenario for the inflation outlook.’
And:
‘A further, but only gradual, pick-up in underlying inflation was expected. The central forecast was for underlying inflation to reach 2½ per cent over 2023.’
The latest inflation print in Australia came out last Tuesday at 3.5%. But that’s not the full picture. The RBA are most interested in the trimmed mean CPI. This is meant to filter out temporary inflation pressures.
The trimmed mean CPI still had a big increase from 2.1% in October to 2.6% in January.
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Source: Tradingeconomics.com |
So the RBA’s previous forecast was that trimmed mean CPI would hit 2.5% sometime in 2023. Given they were clinging to a 2024 rate hike prediction, we can assume they were thinking 2.5% would be hit towards the back end of 2023.
Well, we went and hit 2.6% last quarter. So that blows their forecast out of the water. And brings a rate hike in the first half of this year firmly into the realm of probability:
‘As previously determined, the Board will not increase the cash rate until actual inflation is sustainably within the 2 to 3 per cent target range.’
But there’s another key piece to this puzzle…
Unemployment
The other key metric that every central bank follows is unemployment.
From the RBA’s December meeting minutes:
‘The unemployment rate was expected to trend lower to be around 4 per cent by the end of 2023.’
A longer-term chart highlights where we currently sit with unemployment in Australia:
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Source: TradingEconomics.com |
In December, it fell to 4.2% from 4.6%. As you can see from the above chart, we’re fast approaching the lowest unemployment rate we’ve seen in my lifetime.
Again, this seems to be moving faster than they anticipated. We could hit 4% next month.
So, then the question is, what’s going to happen at this meeting?
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What to watch for
While the case to raise rates is getting stronger, the RBA won’t be moving interest rates today.
The data, as it currently stands, is a comfortable position for them. The rapid movement in both unemployment and inflation will be a concern.
However, they want to guide the market to their decision before they pull the trigger. So today is going to be all about how they talk.
The bond market is currently pricing in the first rate rise to 0.25% for May or June, as you can see in the following chart:
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Source: ASX.com.au |
There are three main things that I’ll be watching for in this RBA decision.
Firstly, I expect that they’ll cease their $4 billion per week bond-buying program. They’ve already signalled that they plan to decide on the program at this meeting.
Secondly, we can expect to see a change in their forecast for rate hikes. They’ll most likely say something to the effect that lifting interest rates may be appropriate before the end of this year.
The meeting minutes come out on 15 February. This will give us more insight into how they’re trying to position the market.
Lastly, the key piece of data that they’ll mention in their minutes is the Wage Price Index, which is next due out on 23 February.
It’s a quarterly figure, so we won’t get another look at it until May. It’s historically quite low but may be turning around. Check out the following chart:
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Source: TradingEconomics.com |
The key here is that wage inflation would underpin sustained inflation across the whole economy. So if wages are heading higher, that’ll give the RBA confidence that inflation is sustainable.
Globally, we’re firmly in a rate hike cycle now. And the RBA is being dragged kicking and screaming along. Today’s decision will be vital in understanding how much urgency they currently feel.
A change in stance today could see big moves in both the bond and share market over the next few weeks until that critical wage inflation data is released.
Until next week,
Izaac Ronay,
Editor, Money Morning
PS: Izaac is also the editor at Exponential Stock Investor, a stock tipping newsletter that hunts for promising small-cap stocks. For information on how to subscribe and see what Izaac’s telling subscribers right now, please click here.