RBA shows dovish colours in its reluctance to raise rates

The RBA board appears to have decided that ‘hold is the new hike’ as it weighs up the risk of a slower return to its inflation target against a bigger-than-expected rise in unemployment.

RBA governor Michele Bullock addresses the media. Picture: Nikki Short

The Reserve Bank says it will do what is needed to lower inflation but prefers to hold rates steady to combat high inflation, rather than restart increases that could tip the economy into recession.

In the minutes of its latest monetary policy meeting, the board said that returning inflation to target was still its “highest priority”. Uncertainty about the outlook for inflation and jobs made it hard to “rule in or rule out” changes in interest rates, implying that rises were still possible.

But after lifting its cash rate target by 4.25 percentage points since March 2020, the RBA board appears to have decided that “hold is the new hike” as it weighs up the risk of a slower-than-expected return to its inflation target against a bigger-than-expected rise in unemployment caused by interest rate increases.

It may be reassuring for the federal government as it gears up for any early election but doesn’t give much hope of relief from high interest rates or cost-of-living pressures over the longer term.

In explaining why the board didn’t decide to lift interest rates this month after recent data signalled that “the risks around inflation had risen somewhat”, the minutes said it considered that the staff forecasts presented a “credible path back to the inflation target”, and the risks surrounding the forecasts were judged to be balanced.

“Importantly, inflation expectations remained well anchored,” the minutes said.

“Given this, and the higher-than-usual level of uncertainty about the economic outlook, members judged that it remained reasonable to look through short-term variation in inflation to avoid excessive fine tuning.”

Australia’s headline CPI inflation rate has been above the middle of the RBA’s 2-3 per cent target band since mid 2021. In August 2021, the RBA said inflation would be back to the middle of the target by the end of 2021.

This month the RBA said it wouldn’t happen until the middle of 2026 – even with the cash rate assumed to stay at the current level of 4.35 per cent until mid 2025.

The board did think that a rate rise could have been appropriate if it its members thought that RBA staff forecasts on the forces expected to “drive down inflation” were too optimistic.

If board members judged that other factors like weaker-than-expected growth in productivity relative to wages, or a rise in inflation expectations, would slow the pace of disinflation, a higher cash rate “might also be required, even with ongoing weakness in aggregate demand”.

NAB head of market economics Tapas Strickland.

But the forecasts showed a “credible path” for the board to meet its objectives in a time frame consistent with its strategy of balancing the risks of a rise in inflation expectations against the risk of a pronounced rise in unemployment.

“These forecasts were underpinned by key judgments that were considered sound and resulted in a balanced set of risks around the central forecasts.”

Moreover, the case to hold the cash rate steady was based on the view that economic data, including higher-than-expected inflation in the March quarter, had “not been sufficient” to warrant an interest rate rise.

“Inflation was still declining towards the target and the recent information did not materially alter its trajectory,” the minutes said.

Holding the cash rate steady could be “an appropriate way to mitigate the risk” of a weaker-than-expected economy “pushing unemployment well above the level consistent with full employment”.

“Similarly, members observed that there is uncertainty about the rate of unemployment that is consistent with full employment,” the minutes said. “Holding the cash rate steady could be an appropriate way to mitigate the risk that the labour market is already close to full employment, which would bring inflation back to target somewhat sooner than envisaged.”

NAB said the minutes showed that holding rates high for longer has become the RBA’s “preferred way to manage risks” of stubbornly-high inflation after recent rate rises.

“It seems holding for longer is the preferred strategy given soft activity, especially on the consumer side, unless CPI were to surprise sharply,” said NAB head of market economics Tapas Strickland.

Mr Strickland said the board’s framing of the case to hold rates steady suggests the central bank is currently “much more concerned about a greater potential slowing in the economy”.

The board tweaked its current post-pandemic strategy for monetary policy which has been balancing the time frame of returning inflation to target, with minimising the rise in the unemployment rate.

In November 2023 the minutes said the board “has a low tolerance for inflation returning to target after 2025”. This month it “expressed limited tolerance for inflation returning to target later than 2026”, thereby pushing out the time frame by one year and further qualifying its tolerance.

ANZ head of Australian economics Adam Boyton. Picture: Sean Davey

“While the board discussed the merit for hiking rates, it clearly has a very high reluctance given weakness in aggregate demand,” Mr Strickland said.

“It would take a sharp surprise in CPI to make a rate hike a real possibility, in which the debate would likely be framed around whether trend productivity growth was turning out weaker than assumed, given policy is assessed to be particularly restrictive for households.”

A rate rise would “have to be predicted on a substantial reassessment of the outlook with signs of inflation moving in the wrong direction,” according to NAB.

ANZ said the minutes suggested the RBA “might be prepared to tolerate above target inflation for a little longer than we’d previously anticipated” after the minutes said the board had limited tolerance for inflation returning to target later than 2026.

ANZ head of Australian economics Adam Boyton said: “We are left with the impression that any resumption of tightening from the RBA would require the board to be of the view that inflation was unlikely to return to the band over the next few years and that the hurdle to act is now higher than November’s risk management tweak.”

ANZ, CBA, NAB and Westpac expect rate cuts to get under way in November.

However, NAB and ANZ now say the risk is skewed towards a later start to rate cuts.