All eyes as RBA governor Philip Lowe to speak on inflation and recent economic data

The Reserve Bank has given some hope that it’s close to the end of its interest rate hikes, but financial markets were less convinced that a pause is imminent.

After being caught out by higher-than-expected core inflation for the December quarter, the emphasis in the February RBA statement was on achieving a restrictive-enough level of monetary policy. Picture: Brent Lewin

The Reserve Bank has given some hope that it’s close to the end of its interest rate hikes, but financial markets were less convinced that a pause in hikes is imminent.

RBA Governor Philip Lowe will speak on “Inflation and Recent Economic Data” early Wednesday.

He will probably flesh out his guidance that “further tightening of monetary policy will be needed.”

If not, asset prices could take off again, causing a “wealth effect” that adds to inflation.

Based on the RBA’s own forecasts – which assume a 3.75 per cent cash rate peak in the second half of 2023, inflation will only be at the top of the 2-3 per cent target bank by mid-2025.

At 3.65 per cent or even the 4 per cent terminal rate now implied by market pricing, the question is whether the RBA can show inflation returning to target in a reasonable time frame, particularly as there’s no sign that its aggressive hikes from a record low of 0.1 per cent are doing serious damage.

There’s no doubt that RBA Governor Lowe’s post-meeting statement – following a widely expected 25 basis point lift in the cash rate to a decade high of 3.6 per cent – was “less hawkish” than February’s statement.

But while it gives the RBA maximum flexibility, it doesn’t mean rate hikes are finished.

In saying that the Board “expects that further tightening of monetary policy will be needed to ensure that inflation returns to target and that this period of high inflation is only temporary,” he removed references to both the timing and number of rate hikes that he previously set for this guidance.

In effect, Dr Lowe made the interest rate outlook more data-dependent than it was in February.

After being caught out by higher-than-expected core inflation for the December quarter, the emphasis in the February statement was on achieving a restrictive-enough level of monetary policy.

In what was perhaps his most hawkish guidance this cycle, Dr Lowe said last month that the Board “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.”

That was reinforced by a warning on the “costs” of inflation becoming entrenched.

That warning was repeated in March. The RBA’s worries won’t disappear so easily.

Lowe conceded that “at the aggregate level, wages growth is still consistent with the inflation target and recent data suggest a lower risk of a cycle in which prices and wages chase one another.”

In other words, there’s less risk of a “prices-wages spiral” which the RBA has warned of in recent months. But it “remains alert to the risk of a prices-wages spiral, given the limited spare capacity in the economy and the historically low rate of unemployment.”

However, wages growth could easily accelerate in response to excessively high core inflation.

If the current level of wages growth was all that mattered, the RBA would probably be forecasting a return to inflation within its target band in a reasonable time frame. That’s not the case.

The main issue is that the unemployment rate remains near 50-year lows and the recent jump to 3.7 per cent looks to have been caused by post-pandemic seasonal distortions.

If the February jobs data next week show the unemployment rate falls back to 3.5 per cent on a 20,000 rise in jobs and a slightly higher participation rate as expected, the market will be more convinced of the need for further rate hikes.

Policy prescriptions for a 3.5 per cent unemployment rate and 6.9 per cent core inflation rate are well north of 4 per cent. March quarter CPI data on April 26th will of course be crucial.

NAB’s Head of Market Economics, Tapas Strickland said, Lowe has merely “opened the door to non-consecutive” rate hikes, particularly as he inserted “when” to his sentence of “in assessing when and how much further interest rates need to increase.”

Strickland says the main reason for the less hawkish tone appeared to be “less fear of a wage-price spiral – which surfaced following the Q4 CPI – “given the recent weaker-than-expected Q4 wage price index and “strong but not excessive” measures of compensation in the National Accounts.”

“The changes to the Statement raises the possibility that the RBA could contemplate pausing in April or May, dependent on the data, even while maintaining a tightening bias,” Mr Strickland said.

“Given inflation pressures, we still think the RBA will hike by 25bps in April and May, taking the cash rate to 4.10 per cent, but today’s Statement does raise the risk of the RBA pausing at 3.85 per cent.”

Goldman Sachs Chief Economist, Andrew Boak, said an “incrementally softer” RBA statement gives some “optionality to pause the tightening cycle” if recent jobs data weakness is sustained.

However, he expects a solid rebound in the jobs data as unusually large seasonal distortions unwind.

“Ultimately, with the unemployment rate near a 50-year low, inflation far above target, substantial excess savings supporting household balance sheets, and the Fed Funds rate likely to rise to 5.25-5.50 per cent – a materially higher RBA cash rate will likely be required to bring inflation back to target on a credible time frame,” Mr Boak said.

“Looking forward, we continue to expect the RBA to raise the cash rate 25bp in April and May to a terminal rate of 4.1 per cent – with the risks skewed to a more elongated tightening cycle to a higher terminal rate.”