CAMA RBA Shadow Board

On the first Tuesday of every month (except in January) the Board of the Reserve Bank of Australia (RBA) meets to decide on a target for the cash rate. This decision is highly significant for the wider economy and is therefore closely monitored by the financial markets. The CAMA RBA Shadow Board, consisting of nine voting members and one non-voting chair, all distinguished macroeconomists, offers its own policy recommendation on the Monday before the official RBA decision. Members give probabilistic assessments of the appropriate target rate for each round, which are then aggregated. The higher the percentage attached to a given cash rate, the greater the confidence that this rate is the appropriate target.

For questions regarding the CAMA RBA Shadow Board, please contact Dr Timo Henckel. If you wish to access the database of past voting records for research purposes, please contact cama.admin@anu.edu.au.

December
2022

Another 25 bps Rise Required to Quell Inflation Going into 2023

On current readings, the Australian economy looks quite strong, especially in light of the tight labour market. On the other hand, in October the monthly consumer price index (CPI) rose by 6.9%, less than in previous months. Furthermore, numerous leading economic indicators, especially consumer and business confidence measures, have weakened further and there is growing confirmation that the global economy is slowing. Considering that the inflation rate remains well above the RBA’s target band of 2-3%, the RBA Shadow Board continues to favour with strong conviction further monetary tightening. In particular, it is 87% confident that the overnight rate should be raised to above the current setting of 2.85%, with a mode recommendation of a 25 bps increase, to 3.1%, whilst only attaching a 12% probability that keeping the overnight rate on hold this round is the appropriate policy.

The official Australian seasonally adjusted unemployment rate dropped a tenth of a percentage point to 3.4%, on the back of a net employment change of 32,200, according to the Australian Bureau of Statistics. The labour participation rate was unchanged, at 66.6%, as was the underemployment rate at 6.0%. Total monthly hours worked in all jobs rose by 3 million. Job vacancies and job advertisements remain close to their historic highs. Overall, the Australian labour market remains tight which, coupled with high inflation, has led to a slight increase in wage growth in Q3, from 2.6% to 3.1% (year-on-year). However, given a headline rate of inflation of 6.9% (October), real wages are continuing to contract significantly.

The Australian dollar rallied strongly throughout the month of November, from an initial low of 63 US¢ to above 68 US¢ by month’s end. Yields on Australian 10-year government bonds declined further from the previous month, finishing the week (2 December) at 3.36%. At longer maturities, the yield curve retains its normal convexity; however, at short-term maturities, the yield curve has inverted slightly, and at medium-term maturities, it has flattened. The spread between 10-year versus 2-year bonds, shrank from 46 bps to 38 bps. The Australian dollar’s rally was matched by a surge in stock prices; the S&P/ASX 200 stock index started the month below 6,900 and finished it above 7,300.

Consumer confidence decreased by 6.9%: the Melbourne Institute and Westpac Bank Consumer Sentiment Index, equal to 83.72 in October, dropped to 78 in November. Month-on-month retail sales contracted slightly, along with private sector and housing credit growth. Business confidence continued its slide; NAB’s index of business confidence fell from 5 to 0. The manufacturing and services PMIs also dropped, from 49.6 to 44.7 and from 48 to 47.7, respectively, as did the S&P Global Australia Composite PMI (from 49.8 in October to 47.7 in November). The capacity utilisation was flat but remains historically high. The six-month annualised growth rate of the Westpac-Melbourne Institute Leading Economic Index, which is interpreted as the likely pace of economic activity relative to the trend in three to nine months, is signalling mildly growing weakness for the coming months.

The housing market, whose performance typically feeds into household spending decisions, is slowing down markedly. Almost all indicators, from building permits and new home sales to private house approvals and the construction PMI, have softened in the past couple of months.

The global economy is unambiguously slowing, especially in the US, Europe and China, in light of persistent supply-side congestions and elevated energy prices. The outlook of these factors depends to a significant degree on how the Ukraine war unfolds, which is of course impossible to predict. Global inflation rates remain high but there are some signs they have peaked, or are about to. A reversal of inflation in the near future is likely crucial to prevent inflationary expectations rising further and becoming entrenched. The Federal Reserve Bank appears to stick to its aggressive interest rate policy to get on top of inflation in the US, creating the risk that, as the US dollar appreciates, other countries are importing higher inflation, forcing their central banks to raise policy rates further. The Organization for Economic Cooperation and Development (OECD) expects a significant slowdown in economic growth worldwide, though it is not predicting an all-out recession. The Institute of International Finance in Washington is forecasting a growth rate for global output of 1.2% for 2023.

For the current (December) round, the Shadow Board is advocating that the overnight interest rate be raised again, above the current level of 2.85%, attaching an 87% probability that this is the appropriate policy stance, with a mode recommendation of a 25 bps increase. The Board attaches a 12% probability that keeping the overnight rate on hold is the appropriate policy and a mere 1% probability that a decrease is appropriate.

The probabilities at longer horizons are as follows: 6 months out, the confidence that the cash rate should remain at the current setting of 2.85% equals 3%; the probability attached to the appropriateness of an interest rate decrease equals 6%, while the probability attached to a required increase equals 91%. One year out, the recommendations are similar. The Shadow Board members’ confidence that the appropriate cash rate is 2.85% equals 1%. The confidence in a required cash rate decrease, to below 2.85%, is 8% and in a required cash rate increase, to above 2.85%, equals 91%. Three years out, the Shadow Board attaches a 0% probability that the overnight rate should equal 2.85%, a 27% probability that a lower overnight rate is optimal and a 73% probability that a rate higher than 2.85% is optimal.

The range of the probability distributions for the current recommendation narrowed a little. It extends from 2.5% to 3.60% (compared to a range of 2.25% to 4.00% in the previous round). For the 6-month horizon it shifted up, extending from 1.75% to 5.25% (compared to a range of 1.50% to 5.00% in the previous round). The range for the 12-month horizon widened from 1.25%-5.25% to 1.50-6.00%. The 3-year horizon range is identical to the 12-month horizon range.

December
2022

No comment.

December
2022

Latest data of the Australian Bureau of Statistics (A.B.S.) shows that annual CPI inflation is now at 6.9 % (trimmed mean inflation at 5.3 %). It’s great news to see a lower CPI inflation than in the previous month and particularly in categories such as fruit and vegetables. However, with one data point, it is too early to say that inflation is coming down. Moreover, the latest Survey of Consumer Inflationary and Wage Expectations shows that the expected inflation rose to 6 percent. This indicates a higher risk that expectations of high inflation may become entrenched. At the same time, the Australian economy has been quite resilient as evidenced by an unemployment rate of just 3.4 %. Given that inflation remains substantially higher than target and the overall economic situation, my view is that the Reserve Bank of Australia should increase interest rates in the next meeting.

December
2022

The incoming data continues to confirm current strong position of the economy and the acceleration in domestic inflationary pressures; wages in the private sector are now rising significantly faster than the RBA’s target for inflation (c.2.5%) plus the pace of long run productivity growth. This outcome is not consistent with an inflation rate of 2-3%, and it is appropriate for the RBA to continue to tighten to ensure that momentum eases in 2023 and supply and demand realign.

But there are some signs that momentum is now easing, which is a necessary first step towards cooling domestic price pressures. Retail turnover declined in October, and when inflation is taken into account this implies a definite fall in the volume of spending. The business surveys are also signalling a slowdown going into 2023, with the forward orders component softening in recent months. Furthermore, there are clear signs that the global economy is slowing down. China’s economy is continuing to struggle with the disruption created by lockdowns, cautious consumers and the ongoing property market correction. And the survey data suggests that the US and Europe are heading into (if not already in) a recession, with retailers having to resort to discounting to clear inventories and businesses paring back their investment plans

Given the inherent delays in the transmission of monetary policy through the economy – the majority of the rate rises that have been announced have not yet flowed through to mortgage holders, for example – it will very soon be appropriate for the RBA to pause and review the impact of the tightening that has already been put into the system. If the current trends continue, this will suggest that monetary conditions have been tightened enough to dampen domestic pressures, which will put inflation on a slow and steady path back to the 2-3% band.

December
2022

No comment.

December
2022

No comment.

December
2022

No comment.

December
2022

No comment.

December
2022

No comment.

December
2022

The RBA’s policy settings are inconsistent with their forecasts. The November SMP projects that inflation will remain above the 2-3% target throughout the forecast horizon while unemployment remains below the NAIRU.

A faster pace of interest rate increases would bring both inflation and unemployment closer to their targets.

The sooner we stabilise inflation and unemployment, the less risk there is of a substantial increase in expected inflation, which would lead to a large increase in unemployment.

The absence of a meeting in January also supports a larger than usual increase this meeting.

Updated:  31 January 2023/Responsible Officer:  Crawford Engagement/Page Contact:  CAMA admin