Reserve Bank reluctant to do more on interest rates

The central bank’s November statement on monetary policy reveals it is reluctant to lift interest rates further, economists say.

The Reserve Bank still expects inflation to hit its target by the end of 2025, but only just.

After restarting rate rises with a 25-basis-point increase in the cash rate target to a decade high of 4.35 per cent this week as inflation proved “more persistent than expected”, the central bank’s ­November Statement on Monetary Policy indicates it is reluctant to lift rates further.

Still, the RBA’s revised economic forecasts – which show annual underlying inflation cooling to 3 per cent by the end of 2025, versus a forecast 5.4 per cent in the September quarter this year – assume the cash rate will hit 4.5 per cent next year before easing to 3.5 per cent by the end of 2025.

Moreover, the statement said that “risk of inflation remaining higher for longer has increased”.

That could lead to an “upward drift in inflation expectations”, which would be “very costly” to reduce in terms of both employment and inflation and “could take a number of years”.

The RBA’s latest forecast for annual “trimmed mean” inflation for the end of 2025 was revised up from 2.8 per cent in the August statement. In May, the RBA expected the core inflation measure to hit 3 per cent by June 2025. In August 2022, it thought inflation would be 3 per cent by the end of 2024.

Annual inflation has been above the RBA’s target band since mid-2021. The relatively small rise in the RBA’s medium-term inflation forecast this month came despite bigger increases in its near-term forecasts. December 2023 trimmed mean inflation was revised up to 4.5 per cent, from 4 per cent. The forecast for June 2024 was revised up to 4 per cent, from 3.25 per cent.

“The RBA’s November statement has not changed our view that the RBA is on an extended pause,” ANZ senior economist Adelaide Timbrell said.

Interest rate risks were “skewed towards further tightening in the near term”, but the RBA’s higher near-term inflation forecasts meant it would be “difficult for the RBA to experience an upside surprise”.

Goldman Sachs Australia chief economist Andrew Boak said the RBA’s revised forecasts implied a 1 per cent quarter-on-quarter increase in trimmed-mean inflation in the December quarter. “This is a reasonably high bar to beat in our view and – alongside RBA liaison flagging moderating wages growth – suggests that the RBA remains a ­‘reluctant’ hiker and is not positioning for further near-term hikes,” Mr Boak said.

“Our base case is that the RBA is now on hold until a gradual easing cycle starting in late 2024.

“Given near-term upside risks to inflation, the balance of risks to this base case is skewed to higher rates in the near term, although over the medium term we think market pricing looks too high given the gradually rising possibility of a downside scenario.”

The RBA’s unemployment forecast for the same period was cut to 4.25 per cent, from 4.5 per cent, but the wage price index forecast over the year to the ­December quarter 2025 was revised down to 3.5 per cent, from 3.6 per cent. Economic growth was revised to 2.4 per cent, from 2.3 per cent.

In its statement, the RBA said services inflation “remains very high, reflecting an environment of elevated domestic cost pressures and still-robust levels of ­demand”.

While expected to cool, services inflation is expected to stay above its average of the inflation-targeting era since the early 1990s throughout the forecast period. Goods inflation has declined substantially since last year as global supply chains improved and inflation in raw materials prices declined, though it was still above average levels.

Measures of inflation expectations have increased recently, but remain consistent with achieving the inflation target over time.

But inflation could fall faster than expected if domestic or international demand is softer than anticipated, the bank says, after increasing the cash rate by 4.25 percentage points since May last year.

NAB said the RBA remained a “reluctant hiker”, yet its forecasts nonetheless justified another rise of 25 basis points in February to provide more assurance that inflation would hit its target in 2025.

“The continued use of the ‘whether’ qualifier when describing the possibility of further hikes is somewhat surprising against the background of the RBA’s inflation forecasts which are conditioned on one further partial hike,” NAB head of market economics Tapas Strickland said.

He questioned if the data needed to further challenge the RBA’s forecasts to elicit another rate rise, or if data in line with the forecasts would be sufficient for the RBA to act on its “mild tightening bias”.

Mr Strickland said the RBA’s forecasts justified another rate rise as they project resilient labour markets and only “very gradual progress on inflation”. NAB expects another rate rise in February.

While it was “surprising” how little changed the 2025 CPI forecasts were despite the large revision in 2023 and 2024, it could be explained by the fact that the RBA’s wage forecasts were little changed, with the RBA still tying its inflation forecasts to the wages outlook and assuming a lift in productivity.

“This leaves the RBA’s inflation forecasts vulnerable should productivity growth not lift sufficiently and, given the statistical noise around productivity and unit labour costs, we continue to suggest looking at services inflation as a better read on near-term productivity,” Mr Strickland said.

Despite services inflation remaining “very high”, the RBA’s business liaison noted that “wages growth is still tracking around 4 per cent, but forward expectations have drifted lower of late”.

Firms “continue to look for operation efficiencies, which is supporting investment in automation and business processes”.

The RBA’s business liaison found slower progress in lowering goods inflation as “the exchange rate and oil prices are slowing the decline in imported costs.”