The Reserve Bank (RBA) board meets next Tuesday and top of the agenda will be the decision on official interest rates.
At its past eight meetings, it hiked every time, by a cumulative record 300 basis points. It did this as it worked to slow the rate of economic growth and, with that, get inflation back towards the 2-3 per cent target band as quickly and painlessly as possible.
Also by the Kouk:
The February RBA meeting will be confronted by two extreme views. The first is that it would be foolhardy, even madness, to hike interest rates - with growth clearly slowing, all of the forward indicators of inflation tracking down and global growth tilting towards a hard landing. The lagged effect of the interest rate hikes already in the system is a further key issue for the ‘rates on hold’ camp.
The other - more hawkish - view from the RBA deliberation will be screaming “hike rates”. Inflation is at a 32-year high and well above the target, the unemployment rate is holding around a 48-year low - which is fuelling an upturn in wages growth - and there is a risk inflation will not drop as hoped unless the economy is squeezed even more with a further rate hike.
That is the core of the interest rate debate in a nutshell.
It is important to recall - and RBA governor Philip Lowe has spoken at length about these push-me, pull-me pressures, especially with 300 basis points of hikes already in the system - that the RBA has a dual mandate: full employment as well as its inflation target.
This greater emphasis on the labour market in recent times is important because it was one of the issues that led to Lowe’s now-infamous statements in 2021 that rates would be on hold until 2024.
While the unemployment rate remains around multi-decade lows, employment did fall in December and the various forward indicators for labour demand in business surveys, the advertisement and vacancy series are all tilting down.
This means, quite obviously and simply, that the best of the good news on unemployment is behind us. The question is the speed at which unemployment rises and what sort of peak the RBA will be content with.
Any unemployment rate above 4.25 to 4.5 per cent would be the result of a policy error because it would unnecessarily add to pain for those added to the ranks of the unemployed. From a macro perspective, it would crimp wages growth and risk an overshoot on inflation to the downside.
Next Friday, after Tuesday’s board meeting, the RBA will release its all-important Quarterly Statement on Monetary Policy. The statement is a must-read for anyone interested in analysis of economic conditions and policy issues. It will include the RBA’s updated forecasts for the economy, where the focus - as always - will be on the RBA calls for the unemployment rate and inflation.
What to expect from the RBA
The RBA forecasts will retain a trajectory for a gradual rise in the unemployment rate through to the latter part of 2024. In the November 2022 Statement on Monetary Policy (SOMP), the RBA was forecasting unemployment to hit 4.3 per cent by the end of 2024, after grinding up marginally to 3.7 per cent by the end of 2023.
These forecasts are likely to be revised higher, with the current slowdown seeing the end-2023 forecast around 4.0 per cent.
Vitally important will be the outlook for inflation.
In the November 2022 SOMP, the RBA was forecasting inflation to fall to 4.7 per cent at the end of 2023 and then further to 3.2 per cent by the end of 2024, after hitting a peak of 8.0 per cent at the end of 2022.
The good news is that the end-2022 inflation rate was below the RBA projection, coming in at 7.8 per cent, and while the outcome was - at one level - not a huge difference, if this parlays over the forecast horizon, inflation will fall faster than was expected in November.
Given macroeconomic and market trends since those forecasts were made, and the marginal undershoot for the December quarter 2022, next week’s forecast update should see a further 0.2 to 0.4 percentage points shaved off the medium-term annual inflation forecast profile.
In other words, inflation will be within the RBA’s target a little earlier than expected, which would all but disqualify the need for further interest rate hikes, including next week.
The February interest rate question will no doubt involve a heated discussion. The RBA board will, after all, be discussing whether it needs to make a few tens of thousands more people unemployed as it works to meet its inflation target. It is a serious decision.
For now, it looks like the case for no change is ahead of the rate-hike case and if that is how it pans out, Lowe will be going some way to restoring his fragile reputation. If the RBA hikes and brings on a hard landing for the economy, he will end his tenure as governor in September with a sorry record.