MNI: Spotlight On RBA Data-Dependence As Labour, GDP Run Hot
Recent data has not printed in line with RBA forecasts, prompting a debate into the Bank's next steps.
Recent stronger-than-expected data, particularly GDP and employment, have fueled debate over whether the Reserve Bank of Australia will be pushed into hiking rates further to pull inflation back to its 2-3% target band, but prominent economists and former staff members were divided, with one seeing room for it to continue its wait-and-see approach.
While August’s unemployment held flat at 3.7% last week, employment strengthened with 65,000 jobs created, illustrating persistently high labour demand. Q2 GDP also held up better than expected, growing 2.1% to June, according to the Australia Bureau of Statistics National Accounts data earlier in the month.
The RBA had expected Q2 GDP at 1.6%, while it wants unemployment at 3.9% by December, according to forecasts within its August Statement on Monetary Policy. (See table) Following the RBA's September decision, former Governor Philip Lowe said some further tightening may be required but noted that inflation had passed its peak and that further rates moves would be data dependent. (See MNI BRIEF: RBA Holds At 4.10%, Inflation Passed Peak)
Sean Langcake, head of macroeconomic forecasting at BIS Oxford Economics and a former RBA economist, said the economy's strength was likely front-loaded. “Not only was that Q2 number a touch ahead of expectations, but the Q1 number revised higher also,” he noted. “I believe that strength has been pulled forward and we will now have softer numbers over the second half."
While ahead of expectations, the central bank will not view the data completely off its trajectory, Langcake added. “The RBA is clearly trying to preserve the labour market gains and the way it’s doing that is by tolerating higher inflation for longer,” he added.
But Warren Hogan, managing director at EQ Economics and a former principal advisor at the Treasury, noted the Bank wanted the real interest rate at zero by the end of the year and had forecasted inflation at 4.1% by December.
“The RBA has been happy to be patient… but that target is now starting to come under pressure,” he said, adding that the RBA must ensure the accuracy of its near-term forecasts.
Hogan added several recent business sentiment surveys have shown that cost, price, labour and energy pressures remain elevated, suggesting the Q2 and July monthly CPI prints were unusually soft. He said Q3 CPI will likely print much higher driven by strong oil prices and could force the RBA to raise the cash rate to 4.35% at the November meeting.
Traders have recently cut expectations for a rate hike next year, with the overnight index swaps market predicting a 4.38% terminal rate and a 126% chance of a 25bp hike by May 2024.
“Not only was GDP strong, but employment was ridiculously strong, and no one should be surprised when demand for labour is through the roof with shortages everywhere and job vacancies at unbelievably high levels,” he continued.
MNI reported last week persistently strong wage growth alongside the tight labour market would continue to add upward pressure on inflation. (See MNI POLICY: Strong Wages To Frustrate RBA's Inflation Hopes) The RBA will focus especially on the September quarter wage data due Nov. 15.
Langcake, however, believes the economy will slow into the end of the year as the services recovery stalls following a strong Q2 performance. He added public, machinery and equipment investment will slow – thanks to a pullback in tax incentives – alongside declines in retail sales and mining exports as inventories have drawn down.
“I see the RBA sitting on its hands from here, basically until late next year,” he added. Recent CPI prints showed inflation had fallen in line with the bank’s expected “narrow path,” Langcake continued. “I think the RBA has given itself a buffer in its forecasts to weather a bit of an upside shock and still credibly say the economy is playing out as expected. It will take a major upside surprise to get it back into action.”