Reserve Bank trims medium-term forecasts for underlying inflation

The RBA has flagged wage growth and more rate hikes as it trimmed medium-term forecasts for inflation in its Statement of Monetary Policy.

Philip Lowe, governor of the Reserve Bank of Australia Photographer: Mark Graham/Bloomberg via Getty Images

The Reserve Bank has trimmed its medium-term forecasts for underlying inflation after assuming a higher-for-longer interest rate path in its revised economic forecasts.

In its quarterly Statement on Monetary Policy, headline CPI inflation is still expected to fall from a four-decade high annual rate of 7.8 per cent at end-2023, to 3 per cent by the end of the RBA’s extended forecast period that runs to mid-2025.

Underlying trimmed mean CPI inflation is also expected to fall, from an end-2022 peak of 6.9 per cent, to 3 per cent – the top of the RBA’s 2-3 per cent target band – by end-2024.

It previously revised up its medium-term inflation forecasts every quarter since August 2021.

The RBA repeated this week’s warning that it expects that “further increases in interest rates will be needed over the months ahead to ensure that inflation returns to target and that this period of high inflation is only temporary.”

But with underlying inflation now expected to be at the top of its target band by end-2024, the forecasts indicate thatinflation will be on the right path after a couple more rate hikes.

Still, its underlying inflation forecasts years ending mid-2023 and end-2023 have been revised up to 6.25 and 4.25 per cent versus a previous forecast of 5.5 per and 3.35 per cent.

And the wage price index is now expected to hit a peak of 4.2 per cent at end-2023 before falling to 3.8 per cent at the end of the forecast period in mid-2025.

Previously, wages growth was expected to peak at 3.9 per cent at end-2023.

Extended forecasts for the unemployment rate show a steady rise to 4.5 per cent at mid-2025.

Growth forecasts have been revised down to 2.75 per cent from 3.0 per cent for end-2022, but increased to 2.25 per cent from 2 per cent for mid-2023.

Sub-trend annual growth rates of 1.5 per cent are still projected from end-2023 to end-2024 before a slight pickup to 1.75 per cent at mid-2025.

The forecasts were based on an assumption that the path for the cash rate reflects expectations derived from surveys of professional economists and financial market pricing.

The RBA says that as of Wednesday, that path showed the cash rate rising from 3.35 per cent to a peak of 3.75 per cent in the second half of 2023, before falling to 3 per cent by mid-2025.

The previously assumed rate path, used in the November forecasts, had the cash rate peaking at 3.5 per cent in mid-2023 before easing back to around 3 per cent by the end of 2024.

Its business liaison found that “growth in the private sector economy has moderated over the past three months. Firms report that conditions remain “generally favourable”.

Activity “continues to be elevated for many firms” and investment intentions are around their long-run average, the RBA added. It said the labour market remains tight, but “there is evidence that labour availability has improved a little over recent months.”

Firms surveyed in the liaison program expect wages growth to stabilise around 4 per cent in coming quarters.

A key concern for most firms is around how household spending will evolve over coming months in response to the higher cost of living and interest rates, and the related implications for the broader economy. Household spending has held up well given the higher cost of living.