RBA’s messaging to the market critical as inflation spike throws thoughts of rate cut up in the air
And no one expects a rate cut at 2.30pm on Tuesday. The shock September quarter inflation figures saw to that.
But governor Michele Bullock and her colleagues must now walk a tightrope.
They must acknowledge that inflation is uncomfortably high while keeping alive the prospect of further monetary easing next year.
The task is made harder by the conflicting signals coming from the economy.
Inflation is running hot, but unemployment is drifting higher.
Before last week’s inflation data landed, Ms Bullock drew a line in the sand.
A 0.9 per cent quarterly rise in core inflation would be a “material miss” against the bank’s forecasts. The actual number was worse. Quarterly trimmed mean inflation of 1 per cent lifted the annual rate to the top of the 2-3 per cent target band.
In August, the bank forecast 2.6 per cent core inflation all the way out to 2027.
The figures have “spooked” the central bank, according to Westpac chief economist Luci Ellis.
“It will likely take more than one quarter to undo the shock,” she says.
Markets have responded swiftly. Back in August, traders were pricing in three more rate cuts by mid-2026. Now they foresee just one cut, and probably not until the third quarter of next year.
That sharp repricing actually helps the RBA’s forecasting task. The bank conditions its economic projections on market expectations for interest rates. With the market now pricing in far less easing, the RBA’s updated forecasts can show a weaker growth outlook and higher unemployment without requiring any change to its inflation projections.
The upshot is likely to be a Goldilocks outcome, at least on paper. But the RBA can’t cut now.
Forecasts may show unemployment rising to about 4.5 per cent – the bank’s estimate of full employment – and core inflation hitting the 2.5 per cent midpoint of the target band.
This picture masks genuine uncertainty about what happens next.
The RBA faces data that’s pulling it in different directions.
On one hand, services inflation remains elevated at 3.5 per cent.
Ms Bullock has pointed to unit labour costs still growing at around 5 per cent as a key driver.
On the other, the labour market is cooling.
Employment and hours worked slowed sharply last quarter. The unemployment rate jumped to 4.5 per cent in September, although that monthly figure can be volatile.
Adam Boyton from ANZ highlights another issue. The September quarter has tended, in recent years, to produce higher trimmed mean inflation readings than other quarters.
Several one-off factors may have pushed the measure higher.
If rates, tobacco and electricity had all risen by a more typical 2.5 per cent, and petrol prices had not changed, trimmed mean inflation would have been 0.14 percentage points lower.
Capital Economics senior economist Abhijit Surya says the disinflationary process has merely been set back, not derailed. As the labour market cools, unit labour cost growth should fall, pulling services inflation lower. Goods inflation, meanwhile, got an artificial boost from the withdrawal of electricity subsidies and that will fade.
“We think prognostications about the end of the RBA’s easing cycle are greatly exaggerated,” Mr Surya says.
Nomura strategist Andrew Ticehurst sees “material uncertainty” about both the unemployment rate consistent with stable inflation and the neutral interest rate.
“The best approach in this environment is to allow incoming data to dictate future action,” he says.
That approach has been compared with driving while looking in the rear-view mirror; It risks policy errors.
But with the economy growing near trend and rates getting close to “neutral”, any mistakes should hopefully not prove costly at this point.
The communications challenge is acute.
The statement will almost certainly describe the labour market as still “a little tight”, reinforcing the hawkish tone demanded by the inflation surprise.
But Ms Bullock has previously said monetary policy remains “a little restrictive”.
If the RBA backs away from that view, it would be “a material hawkish development” that would jolt markets, according to Mr Ticehurst.
More likely, the bank will emphasise heightened uncertainty and the need to gather more data. Specific guidance on the timing or direction of the next move may be sparse.
NAB’s Taylor Nugent expects “little guidance” as the RBA seeks “more understanding of labour market and inflation dynamics”.
The market has already done much of the heavy lifting, pricing out the near-term cuts the RBA can no longer deliver. But the revised forecasts have to take account of the fact that market pricing now predicts two rate cuts fewer than it did in August.
That will keep hopes of more rate cuts alive, barring a broadening cyclical upswing.
The bank’s challenge is to use Tuesday’s statement and press conference to keep its options open without sounding so dovish that it reignites inflation expectations, or so hawkish that it locks itself into an extended pause it may come to regret.
Getting that balance right will require all the governor’s communication skills.
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