Reserve Bank revolution begins – but inflation remains its key issue

For generations, the Reserve Bank board has met on the first Tuesday of the month to set interest rates.

On Monday, that ends as part of sweeping reforms to the RBA that will weigh on the economy, any person with a job or who runs a business, and the millions of people struggling to deal with the bank’s aggressive interest rate increases of the past 21 months.

And this week’s inflation data, on top of evidence tight monetary policy has delivered a devastating financial blow to consumers, means the bank will have to dramatically re-cast its economic outlook to the point that some analysts believe official interest rates could be falling as early as May.

A more open RBA - the biggest changes to the Reserve Bank in generations get under way from Monday.Credit: Louie Douvis

Like clockwork, members of the Reserve Bank board have taken their seats in the RBA’s Martin Place headquarters about six storeys above the passing traffic on the first Tuesday of every month bar January. Over a few hours, they would consider a recommendation from the bank governor (more often than not to hold interest rates steady) while quizzing senior staff about the economy before agreeing on a course of action.

But as part of changes set in train by the independent review of the Reserve Bank, the board members will now sit down on Monday afternoon.

Over several hours, they will tease out issues raised by staff in their various reports and consider scenarios for the economy while testing senior officials on their views.

The next morning, the board members will re-convene to determine whether interest rates need to change and then work with governor Michele Bullock and other staff on a statement that will be released at 2.30pm.

An hour later, Bullock will hold a press conference to explain the bank’s thinking and to discuss updated economic forecasts from the Reserve that will be released alongside the interest rate decision.

And, rather than go through the entire process on March 5, the next two-day meeting will be on March 18. Instead of 11 monthly meetings a year, the bank will shift to eight.

For a bank that until 2008 waited a full day before announcing an interest rate change, and which did not hold a formal press conference until 2020, the reforms are extraordinary steps.

Luci Ellis, a former Reserve Bank assistant governor who is now Westpac’s chief economist, says the change to a two-day meeting will give members more time to drill down into the economy.

“This will give the board more time to discuss the outlook and risks, and the staff more time to present scenarios and other analysis that could not easily be fit into the agenda in the previous shorter-format meeting,” she says.

The economic outlook and risks have changed dramatically since Bullock’s last public comments on December 12.

Pressed on whether the bank was behind its international peers in terms of interest rate settings, the governor explained the RBA’s then-current thinking.

“We are trying to make sure we slow the economy enough to bring inflation down to our target band. Provided inflation expectations don’t get out of control – and they are not at the moment – we think we can do that in the next couple of years and we can do that while preserving the employment gains that we’ve won through the pandemic and coming out of the pandemic,” she told a summit in Sydney.

“I think we’ve taken a cautious approach and we will continue to watch the data.”

The data since that statement has been in one direction.

Unemployment has pushed up. It was at 3.5 per cent mid-year but finished 2023 at 3.9 per cent, while job vacancies have continued to ease. There’s been a huge fall in the proportion of businesses saying staff shortages are a constraint on their operation.

Consumer demand, as measured through retail sales, is extremely weak. It fell 2.7 per cent in December, the biggest pre-Christmas fall on record. In per capita terms, retail spending tumbled 6.5 per cent through last year. That sort of fall is recessionary.

To cap it off came this week’s inflation data.

Back in December, the RBA reckoned inflation – both headline and underlying – would ease to 4.5 per cent by year’s end.

Instead, Wednesday’s quarterly consumer price index showed headline inflation at a two-year low of 4.1 per cent and underlying at 4.2 per cent. A year ago, it was 7.8 per cent.

In central bank terms, that’s a big downside miss in a very short period.

The more volatile measure of inflation was even lower, at 3.4 per cent. In December 2022, it was at 8.4 per cent.

The steep fall in inflation lifted the Australian sharemarket to a record high and also forced financial markets to re-evaluate the direction of monetary policy. They’ve now put the chance of a rate cut in May at 50:50, with two cuts priced in by the end of the year.

By the middle of 2025, the official cash rate could be at 3.35 per cent. On a $600,000 mortgage, that would save a borrower more than $400 a month.

Bullock’s last official statement on monetary policy was following the RBA board’s December 5 meeting, at which the cash rate was held steady at 4.35 per cent.

Reserve Bank governor Michele Bullock will face her first press conference on Tuesday. Credit: Lisa Maree Williams

“Whether further tightening of monetary policy is required to ensure that inflation returns to target in a reasonable timeframe will depend upon the data and the evolving assessment of risks,” she said.

In central banking jargon, it meant the bank retained a “tightening bias”. In layman’s terms, the bank was warning potential and existing borrowers that interest rates might still go up.

A variation of that line featured in all the bank’s post-meeting communications through 2023.

But that is likely to be absent from Bullock’s first statement of 2024. Trying to argue that the bank may lift interest rates further, while inflation is falling and the full impact of past rate rises has yet to work its way through the economy, would undermine the RBA’s credibility.

The statement itself will differ from its predecessors as it will be issued on behalf of the RBA board, rather than just the governor.

This goes to another change to the bank that kicks in this year.

Apart from the two-day meeting to consider interest rate settings, the other major recommendation of the RBA review was the creation of a standalone committee to consider monetary policy.

At present, the RBA board manages both rates and the institution (with its 1575 staff), which last financial year suffered an accounting loss of $6 billion. The Reserve is responsible for the nation’s money supply and the high-level functioning of the financial system.

Treasurer Jim Chalmers remains hopeful these responsibilities will be split into separate committees from July 1, with one focused solely on the ins and outs of monetary policy while the other will concentrate on the bank’s other functions.

Currently, the board is made up of Bullock, Treasury boss Steven Kennedy, trained economist Ian Harper, Carolyn Hewson, Iain Ross, Elana Rubin, Carol Schwartz and Alison Watkins. New deputy governor, the Bank of England’s Andrew Hauser, has yet to take up his post.

While the board will issue the statement setting out Tuesday’s rates decision, it will be Bullock facing a room full of journalists explaining the bank’s thinking about the economy.

Treasurer Jim Chalmers hopes to have other changes to the Reserve Bank in place by the middle of the year.Credit: Alex Ellinghausen

Philip Lowe was the first RBA governor to conduct a press conference, holding a handful through the COVID-19 pandemic to explain the bank’s extraordinary policy responses.

Bullock has handled questions from the press (and interested onlookers) at the end of some of her speeches as deputy governor and now governor, but has not gone through a grilling that is an Australian press conference.

This week, the head of the US Federal Reserve, Jerome Powell, conducted his regular post-interest rate meeting press conference. Respective and informed economic journalists put their questions to Powell, who balanced his answers between deep theory and the everyday.

As many political visitors to these shores have found, the Australian press is a tad more aggressive than its overseas counterparts. Bullock is likely to face strident questions about the property market, cost of living and the federal government’s overhaul of the stage 3 tax cuts.

The Reserve Bank, which has failed to hit its 2-3 per cent inflation target since early 2015, is one of the nation’s most important economic institutions.

That institution is about to embark upon nothing short of a revolution. But for millions of Australians, the most important change will be to their mortgage repayments – and if they’re going to get smaller.

Cut through the noise of federal politics with news, views and expert analysis from Jacqueline Maley. Subscribers can sign up to our weekly Inside Politics newsletter here.