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RBA Board to Hold Policy Steady – Lower Unemployment Forecasts

The Reserve Bank Board meets next week on May 4.

That will be followed by the May Statement on Monetary Policy which will print on May 7.

This could be quite an important meeting.

In recent times the meetings which have been linked to the Statements on Monetary Policy have incorporated policy initiatives.

In November last year the Board cut the overnight cash rate from 0.25% to 0.1% and announced the first program of Quantitative Easing (QE).

In February, the Board announced that it would extend the QE program to a second $100 billion tranche.

Our central view is that the announcements we expect around policy changes – an extension of the Yield Curve Control Policy (YCC) to target the November 2024 bonds from the April 2024 bonds; and a third QE program of $100 billion to begin in the first week of September will come at the time of the August Board meeting and the August Statement on Monetary Policy on August 3 and August 6 respectively.

The other policy change we expect – a winding down of the Term Funding Facility which must be drawn by June 30 could be announced at the May meeting.

Of the two initiatives we expect in August the most likely policy to be announced in May would be the extension of YCC to the November 2024 bond.

These policy decisions are going to be reflective of what we assess is a decision by both the fiscal and monetary authorities to maintain maximum stimulus for the economy in 2021 as policies are aimed at driving down the unemployment rate.

In a note on QE earlier this week we forecast that , given our Budget and QE forecasts, the RBA would hold around 38% of all bonds on issue by June 2022 and 52% of all bonds in the 4–12 year maturity range. We concluded that those shares would represent the upper range of the RBA’s comfort zone given its commitment to a smoothly functioning bond market.

However, despite this clear plan the government will be unable to avoid a significant fiscal tightening in 2021/22 with the Budget deficit shrinking between 2020/21 and 2021/22 by around $75 billion (around 3.7% of GDP).

That means that monetary policy will have to remain highly stimulatory and the Reserve Bank may decide to support that approach by announcing the extension of policy stimulus potentially earlier than the timing in our central view (August Board meeting).

Policy decisions will be influenced by the revised forecasts which the Bank will release in the Statement on Monetary Policy on May 7.

The most important forecast revisions will be with respect to the unemployment rate.

Recall that when the Bank last printed its forecasts on February 3 the most recent unemployment print was for December 2020 at 6.8%.

The forecast at that time was a fall to 6% by December 2021 and 5.25% by the end point of the forecast period which is June 2023. The next extension of the forecasts to December 2023 will print in the August Statement on Monetary Policy.

Following the March employment report the unemployment rate has already fallen to 5.6% (a fall of 1.2 ppt’s in three months). We are also seeing other data series including job vacancies and Consumer Confidence on an industry basis to suggest that the impact of the winding up of JobKeeper at the end of March may have had a much milder impact on jobs than had been originally expected.

For example, our own estimate of a total loss of jobs of 100,000 (given that 1,000,000 employees were receiving JobKeeper in March) centred on the most Covid affected industries such as food and accommodation losing 25,000 jobs. However, job vacancies and confidence amongst employees in that sector are high. Westpac has lowered its forecast for the unemployment rate by end 2021 from 5.7% to 5.0%

I expect RBA will be somewhat more cautious than we have been and lower their forecast rate from 6% to 5.25%. That profile might encompass a flat unemployment rate (to 5.75%) by June followed by a 0.5 ppt drop in the second half of 2021 – comparable to the expected fall in 2021 H2 in the February Statement when it was forecast to fall from 6.5% to 6.0%. From a policy perspective the key will be the forecast out to the end of the forecast period (June 2023).

The RBA is already forecasting above trend GDP growth in 2022 of 3.5% (which we expect to be retained) which is 0.5% above Westpac’s forecast but employment growth of only 1.25% in 2022 – well below our forecast of 1.9%.

This disparity is likely to reflect a different view on population growth in 2022.

With prospects for the reopening of foreign borders by early 2022 fading the downbeat RBA view on population growth is unlikely to be changed.

The other difference between Westpac and the RBA is likely to be around the participation which we expect to hold at record highs as female participation continues to rise. A likely boost to affordability of childcare services in the Budget will only support a further lift in female participation.

Taking all these factors into account our best estimate is that the RBA will lower its forecast for the unemployment rate by June 2023 from 5.25% to 4.5% – the same 0.75 ppt fall between end 2021 and June 2023 that was forecast in February (i.e. 6% to 5.25%). With this much lower starting point for the unemployment rate as we move towards 2024 could the RBA moderate its assessment that the conditions necessary for a rate increase are unlikely to be met “until 2024 at the earliest”?

That seems highly unlikely for the following reasons:

  • We expect that the RBA estimates that an unemployment rate of 4% or less is now equivalent to full employment.
  • The forecasts into 2024, which will not print until February 2022, are likely to envisage a 4% unemployment rate (a touch above the RBA’s expected estimate of full employment); but it will be necessary for the unemployment rate to hold at full employment level for some time before adequate upward pressure on wages and prices can be expected to eventuate.
  • In the current atmosphere, both in Australia and globally, where central banks are embracing patience and consistent stimulatory stances a decision to change the key message to a more hawkish tone would be counterproductive and risk (as we saw with the Bank of Canada this week) unwelcome upward pressure on the Australian dollar.

The other forecasts that will come under some scrutiny will be the inflation and wages forecasts.

The February forecasts for the inflation rate are cautious. The trimmed mean is expected to increase by 1.25% in 2021 and 1.5% in 2022 and by 1.75% in the year to June 23.

The 0.3% which printed for the March quarter and surprised markets was partly impacted by the government subsidies for housebuilding which based on the Australian Bureau of Statistics estimates we estimate would have subtracted 0.2 ppt’s from the measure. However, the impact of the subsidies on demand can be expected to have distorted the measure to the upside and other components of the March quarter CPI also surprised to the downside.

Based on the forecasts in the February SOMP the RBA is expecting another read of 0.3% in June for the trimmed mean to reach the current forecast of 1.25%.

We do not expect there to be any changes in the forecasts for the trimmed mean inflation in the May SOMP emphasising that the RBA still expects a real challenge to achieve a sustainable inflation rate above 2% in 2024.

The current forecast for wages growth by the end of the forecast period (June 2023) is 2%. With a lower forecast path for the unemployment rate there may be some “tweaking” of forecast wages growth by, say, 0.25% to 2.25%, which was consistent with the pace of wages growth we experienced in NSW in the pre Covid period when the unemployment rate in NSW dropped below 4.5%.

But even if the forecast is lifted to 2.25% it will still be well below the level at that stage of the cycle (June 2023) that would give markets reasonable confidence that the target of 3% + can be achieved by 2024.

In summary, we do not expect changes in the forecasts in the May SOMP that would indicate a marked lift in the RBA’s level of confidence that it will achieve its inflation; wages and employment targets by 2024.

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