The minutes of the November monetary policy meeting of the Reserve Bank Board confirm the confident approach we have seen in the recent Statement on Monetary Policy.
While consumption growth is still identified as a source of uncertainty, the Board expects it to remain around the 3% level over the next few years that we have seen recently. Household disposable income growth is also forecast to increase at that rate.
GDP growth and labour market conditions have been stronger than the RBA had expected over the last twelve months. Accordingly, the forecast for the unemployment rate has been lowered to 4 ¾ per cent from 5 per cent by mid-2020, with an implied downside risk to that forecast. With the improved labour market outlook, there has been a modest upward revision to the outlook for wages growth. This is a particularly encouraging development for the RBA as they see wages growth as the key uncertainty for future consumption growth and inflation.
In that regard, the forecast for inflation has been lifted modestly, reflecting the brighter outlook for economic activity, the labour market and wages. Non-mining business investment was expected to continue to make a significant contribution to output growth supported by above average business conditions and the significant pipeline of non-residential construction work.
Their discussion around the housing market is less confident. Residential building approvals are recognised to have fallen in the September quarter and liaison with builders describes a difficult picture. Furthermore, it is noted that housing prices have fallen further in Sydney and Melbourne, although are stable in most other cities. With the RBA’s core forecast that consumption and income growth will be aligned, there is no allowance for any negative wealth effects from these housing developments.
The minutes discuss the various policy stances of other central banks noting that “market pricing was consistent with policy rates remaining steady over the following year in Australia and New Zealand, where policy rates had not been lowered to the extent they had in some other economies”.
The Board also discussed the RBA’s forecasting performance over the previous year, noting that forecast errors were smaller than historical averages with GDP growth and business investment surprising to the upside, the terms of trade average being higher than expected, and the marked depreciation in the Australian Dollar. Labour market outcomes were also stronger than expected, although wages growth and inflation had evolved largely as expected.
Consequently their success in the forecasting of inflation and wages despite underestimating employment and growth forecasts is a result that would have puzzled the forecasters.
The conclusion has been that the lags between growth; unemployment; and wages/inflation are larger than had been expected.
The question is just how long are these lags?
Westpac is expecting growth to slow down in 2019 and the unemployment rate to move back to 5.3% through mid2019. That development would interrupt the steady gradual improvement the RBA is expecting.
This expected gradual lift in wages growth represents the key to the RBA’s expectation for higher rates. The importance of wages in boosting incomes and inflation is paramount in the RBA’s thinking so it is instrumental to get an insight into just how quickly the RBA expects wages growth to lift. Note the comments in the minutes that Australia requires “a gradual increase in wages growth for inflation to be sustainably within the target range”.
That outlook was provided in a graph (reproduced from the November Statement on Monetary Policy) where the RBA’s own forecasts for annual growth in the Wage Price Index are presented for the first time.
We are not given the point estimate by end 2020 but it certainly “eyeballs” at comfortably below 3%. (arguably around 2.75%).
Consider the growth rate of the WPI at the point of the beginning of the previous five rate hike cycles.
The start dates of the five previous rate hike cycles were May 2002; November 2003; May 2006; August 2007; and October 2009.
The latest WPI prints at the time of those meetings were an annual pace of 3.5% in December 2001; 3.2% in June 2002; 4.1% in December 2005; 4.0% in March 2007 and 3.7% in June 2009.
These are much faster growth rates than the RBA is expecting by end 2020 raising the question as to whether despite the confident assertion that the next move in rates is likely to be up, the RBA is anticipating such long lags between growth and wages/inflation that it will be surprised if the case to raise rates will even be clear by end 2020.
The RBA itself might be expecting to continue with “there was no strong case for a near-term adjustment in monetary policy” for a lot longer than is commonly assumed.
There may be other surprise developments such as a rapid fall in the Australian dollar which would trigger a response from the RBA. However, its forecast of a gradual build up of wage pressures indicates that they expect to be patient for a lot longer than generally believed.
My own view is that wages are close to peaking as the housing bust and election season stall the economy into H1 2019. Unless it cuts, the RBA will find itself watching wages crash with domestic demand in 2019.
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.
He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.
