MNI INTERVIEW: RBA Rates View To Survive Productivity Miss

MNI (MELBOURNE) - The Reserve Bank of Australia’s forecasts for productivity growth are likely to prove over-optimistic, but its MARTIN forecasting model means this likely shortfall would prompt only minor adjustments at most to its CPI and cash rate assumptions, the Bank's former head of research told MNI.  

The Reserve’s most recent forecasts, which expect productivity growth to jump from 0.1% in Q4 to 1.9% by Q2 2025, are out of line with recent National Accounts data that showed a fall of 0.8% over the June quarter, said John Simon, adjunct fellow at Macquarie University and head of the economic research department at the RBA between 2014-2024. 

“There would be differences of opinion about how realistic that assumption is in the current environment but it is certainly much stronger than we’ve experienced recently,” he said in an interview. “When you look at the bottom line that productivity estimate feels optimistic.” 

Former RBA officials have consistently questioned the Reserve’s productivity assumptions believing weaker growth could impede cuts. (See MNI: RBA To Hold Rates Despite Soft Data - Ex Staff)

However, Simon noted the RBA’s MARTIN model allowed deviations of individual data points without significantly impacting the wider forecast, unlike structural dynamic stochastic general equilibrium models that rely on integrated key assumptions. 

"My expectation is that there would be a number of offsetting changes,” he continued. “Something goes up, something goes down, and so the net effect isn't as if the only thing that changed was productivity. So while I would expect changes, I wouldn't expect that they'd be dramatic.” 

Productivity, however, remains a key issue for the Australian economy, Simon stressed, noting sluggish GDP growth of 1% y/y in Q2. “The kind of rates of [GDP] growth we're seeing can still end up being too high, given that the productive capacity of the economy hasn't been growing nearly as fast." 

MARKET DISCONNECT

The RBA should have hiked the 4.35% cash rate higher which would have allowed easing sooner, Simon argued, adding that poor communication had driven a divergence between market pricing and the Board’s more hawkish tone.

Overnight index swaps have priced in a 4.16% cash rate by the end of the year, a sharp point of difference from Governor Michele Bullock’s rhetoric that has largely ruled out any 2024 easing.

“A path of holding them at a particular level for longer risks entrenching inflation expectations,” he added. “But my primary point is that exploring all those options and views is an important part of making the best decision possible. The decision would be stronger if we had experts on the Board who could advocate for these alternatives using the kind of data and analysis that the Bank itself uses.”

Pointing to 2023’s RBA Review recommendations that called for greater external macroeconomic expertise on the board, Simon added the lack of any public disagreement among Board members over the last 10 years showed the Reserve had been less interested in fostering policy debate. (See MNI: RBA Board Changes Missed Opportunity - Ex Policymakers) 

“But when the reforms are passed… we will start to get a better impression about exactly what the nature of the debate is and what the thinking is on that front,” he said, pointing to this week's stalled negotiations between the government and opposition. 

“This kind of [market] divergence at the moment is something that warrants further discussion in public, and I look forward to the bank discussing that in their public statements and the Governor’s press conferences."