MNI INTERVIEW:Neutral Update Needed After Fourth Pause- Ex RBA

The Reserve Bank of Australia is likely to revise its models on the relation between employment, wages and monetary policy to better reflect how the economy, particularly the labour market, has responded to higher rates, according to a former senior Reserve economist.

Despite the rapid 400bp increase in the RBA’s cash rate, unemployment has only moved slightly above 50-year lows, according to Michael Blythe, chief economist and co-founder at PinPoint Macro Analytics. “How does the RBA explain that?” he asked. Blythe worked at the RBA between 1983-1995 and was Commonwealth Bank of Australia’s chief economist from 1995-2020.

“I think that’s a critical question – it's either telling us that policy settings are not tough enough or there has been a fundamental shift in how the economy works and what does this mean for policy settings in general?”

The RBA board has held the cash rate at 4.1% for the past four months, (See MNI RBA WATCH: New Governor Points To Oil Prices), but the elevated stance has had little impact on unemployment with the latest Australian Bureau of Statistics data showing the jobless rate at 3.7% for August, 10bp higher over the previous month, while job creation was stronger than average at about 65,000.

Governor Michelle Bullock noted tight labour market conditions were easing following the board's Oct 3 decision. The RBA is targeting an unemployment rate of 3.9% by the December quarter and 4.5% by late 2024 when it expects CPI at 3.3%, still above its 2-3% target band.

Blythe noted wages had failed to grow how economists had anticipated. “There’s something different in the way the economy is operating,” he noted, calling on authorities to develop monthly wage data. While the RBA has access to monthly CPI data, the ABS only updates the wage price index quarterly, with the next print due Nov 15, well after the RBA’s Nov 7 decision.

NAIRU, R*

Blythe noted the RBA is likely to update estimates for the non-accelerating inflation rate of unemployment (NAIRU) and the neutral interest rate soon. The Treasury’s recent employment white paper may also lead to the production of several unemployment measures, he added. (See RBA To Look At Underutilisation In NAIRU Revamp)

“We get these occasional remarks on where they think neutral is and we can track that over time, but it’s a movable feast and it does change with the economy, so an official estimate would be good – other central banks have this as part of their overall debate and I would be surprised if we didn’t see something on this next year,” Blythe said.

The RBA's 4.5% NAIRU estimate has not changed since 2019 despite its pre-Covid downward trajectory, while the Reserve has struggled internally to apply its neutral estimates. (See MNI: RBA Needs To Cut NAIRU Estimate - Ex-Staffers)

EXHANGE RATE, BOND YIELDS

Blythe noted the recent bond selloff will further weaken the Australian dollar and add to inflationary impulses, though the nation’s current account, which came into surplus in 2019 for the first time since 1975 (see chart), should keep a floor on the currency.

However, the rise in longer-term bond yields will eventually filter into fixed-interest rates and the mortgage market, further slowing the economy, he added.

PLATEAU AHEAD, FOR LONGER

Despite the challenges ahead, Blythe expects the cash rate to hold at 4.1% barring significant inflationary surprises. Recent history suggests the average time between the last hike and a cut is about eight months, he continued.

“However this time it will take a bit longer and that seems to be the emerging theme coming from pretty much all central banks at the moment wanting to hose down expectations of cuts this year or sometime in early 2024.”