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Inflation Gap Needs To Close For Rate Model To Imply Easing

AUSTRALIA

The RBA revised down its growth and inflation outlooks for 2024 in its February Statement on Monetary Policy. This impacts the inflation gap, difference between headline and the target mid-point (2.5%), and output gap variables in our policy reaction function. As a result, the estimated peak in rates is around 50bp lower than in November but the inflation gap needs to close for estimates of easing.

  • The inflation gap remains positive throughout the RBA’s forecast horizon while we estimate that the output gap should close around mid-2024 and be slightly negative through next year. This drives the model to estimate one more hike in 2024 based on these economic fundamentals with rates levelling off after that.
  • The equation has a forward looking component with the inflation gap leading by two quarters. The reaction function only begins to imply rate cuts once this gap closes, which is not yet in the RBA’s forecasts with Q2 2026 at 2.6%. Governor Bullock said the further out the projections the greater the uncertainty though. The Q4 2024 gap improved 30bp with the RBA’s February revision.
  • We also have an equation that includes CoreLogic house prices and since they began rising again in Q1 last year, it has been estimating the cash rate at a higher level than without house prices.
Australia RBA cash rate estimations %

Source: MNI - Market News/Refinitiv/Bloomberg/RBA

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