RBA Minutes: not confident in their forecasts for inflation

Tapas Strickland | Markets Research

Key points:

• RBA Minutes highlight the Board is not confident in their inflation forecasts
• Key uncertainties: supply capacity, productivity growth, and how restrictive policy actually is
• In contrast, less worried on the labour market: “risks…might have diminished somewhat”
• A cut as soon as February looks too early: “would need to observe more than one good quarterly inflation outcome to be confident that such a decline in inflation was sustainable”
• NAB recently moved its cash rate cut call to May (from February), and these Minutes highlight the real risk that rates stay on hold even deeper into 2025

Summary:

The RBA Minutes were not expected to contain much new information, though they did highlight the key uncertainties the Board is grappling with. Overall, the discussion highlights that a rate cut as soon as February looks very unlikely given policy is only modestly restrictive and the uncertainties the RBA is grappling with are unlikely to be resolved that quickly. In the event that the labour market remains resilient and broadly tracks as forecast while inflation eases by more, the RBA Board notes “they would need to observe more than one good quarterly inflation outcome to be confident that such a decline in inflation was sustainable”.

NAB recently changed its rate cut call to May (from February), while also highlighting the risk that rates stay on hold deeper into 2025. The Minutes are broadly consistent with our May view, but on our read will require some further loosening in the labour market (which we forecast) and two quarterly inflation prints consistent with further easing in inflation pressures (which we are also forecasting). There was also a wide discussion of scenarios where the RBA may have to hold for longer, raise or cut rates. While a laundry list, they do reveal how the Board’s thinking about risks. Key observations from these discussions below:

Observations of note:

• RBA less worried on the labour market: The Minutes note that “labour market conditions remained tight relative to full employment.” And that some indicators such as underemployment suggested that “the easing in the labour market might have begun to stall or modestly reverse”. Given this “the risks of a rapid deterioration in labour market conditions might have diminished somewhat, though such a scenario could not be ruled out”.
  
  
  • In the discussion of scenarios, one scenario was presented where the labour market eased more materially than expected. This would in turn lower inflation more rapidly and see the RBA cutting rates. However, as noted above, this scenario appears less likely given the fall back in underemployment and youth unemployment recently.

• RBA remains concerned about the assumed pickup in productivity: Productivity growth in Australia has been weak, particularly in construction and mining. Board members noted that “wages growth would need to slow even further to enable a return to the inflation target if productivity growth does not increase as assumed”.
  
  
  • In the discussion of scenarios, there was one scenario where the supply capacity of the economy was materially more limited than assumed in the forecasts. This would require a tightening in monetary policy. Evidence this risk was being realised could come via realised too high inflation outcomes or a sequence of unfavourable productivity readings.

• How much household consumption will pickup: The RBA expects household consumption to pick up as real incomes rise. The Board noted that “a range of higher frequency data tentatively suggested that household consumption growth had increased in the September quarter”, but this was a little less than forecast back in the August SoMP.
  
  
  • In the discussion of scenarios, there was one where consumption provided to be persistently and materially weaker than the staff forecast. In that scenario it would likely lower inflation significantly with a reduction in the cash rate being warranted. The converse of that is if consumption growth rose sharper than expected which may require policy to remain on hold for an extended period.

• Still not clear how restrictive policy is: The RBA have been noting some uncertainty over recent meetings about how restrictive policy is. While financial conditions are still judged to be restrictive overall, “there had been a modest easing in some indicators over preceding months”. The Board appears to be looking at the rise in housing and business credit growth, nothing that “this was somewhat unusual in a period of monetary policy tightness”.
  
  
  • The recent SoMP also had a comparison of policy restrictiveness amongst peer economies, showing that “the gap between policy rates and estimates of neutral remains smaller in Australia than for central banks in most other advanced economies, despite many other central banks cutting rates multiple times” (see chart below),
    
    
  • In subsequent discussion of scenarios, there was one hypothetical scenario where “the stance of policy was not as restrictive as had been judged”. And “agreed that it was important to pay close attention to potential signs of this, including developments in credit growth, banks’ willingness to lend and growth in asset prices”.
    
    
  • Assistant Governor Kent also gave a speech last night, noting: “there is no evidence that monetary policy is stronger in Australia than in other advanced economies. This finding may appear to be at odds with the comparatively large stock of variable rate mortgage debt carried by Australian households and thus their exposure to significant interest rate risk. But this apparent conflict can be reconciled when one considers the various ways that interest rate risk is managed in Australia, as well as the effects of the other important channels of the transmission of monetary policy.” That assessment is not new from the RBA, though the natural question out of that is whether the RBA was right in not raising rates as high as other central banks (see RBA’s Kent: The Financial System and Monetary Policy in Australia).

Chart 1: RBA's policy is not that restrictive compared to other countries, even when they have already cut rates - chart from the November SoMP which was discussed as seen in the Minutes today.

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