RBA shifts to a more hawkish tone; February now live

Sally Auld | Group Chief Economist 

Key Points

• In a unanimous decision, the RBA’s Monetary Policy Board left the cash rate on hold at 3.6% in December, as anticipated by the market and forecasters alike.
• Our expectation of a shift towards a more hawkish tone in December was realised. The Statement no longer refers to downside risks to the growth and inflation outlook.
• February is now a live meeting for a rate hike.

Bottom line

The RBA Monetary Policy Board delivered a short Statement today, reflecting a shift in the distribution of risks to both inflation and growth. This represents a further step in a hawkish direction, and sets the RBA up to deliver a February rate hike should there be more evidence of a growth pick up and / or evidence that inflationary pressures are persisting.

Detail

A run of stronger-than-expected outcomes on activity and prices data in recent months have forced a considerable reassessment of the outlook for the Australian economy, nicely summarised by these sentences: “…the data do suggest some signs of a more broadly based pick-up in inflation, part of which may be persistent and will bear close monitoring. Economic activity continues to recover. Growth in private demand has strengthened, driven by both consumption and investment. Activity and prices in the housing market are also continuing to pick up.” Indeed, the Statement is clear that risks to inflation have now titled to the upside.

Despite uncertainty in the global economy, global risks have largely been dismissed in terms of their impact on the domestic economy. Moreover, the softness in the Wage Price Index has also been relegated, with the Statement instead noting “…broader measures of wages continue to show strong growth and growth in unit labour costs remains high”.

The Statement retains the view that there remains uncertainty about the stance of monetary policy, and as always, about the outlook for economic activity and inflation too. But the Statement cautions that if the pick-up in momentum in the domestic economy continues, it will add to capacity pressures. This is against a backdrop where the starting point is described as “measures of labour underutilisation remain at low rates, surveyed measures of capacity utilisation are above their long-run average and business surveys and liaison continue to suggest that a significant share of firms are experiencing difficulty sourcing labour…” and so suggests little tolerance for upside surprises.

The RBA has little room to absorb any further surprises without recalibrating policy. The economy has returned to its trend growth rate, the recovery in private demand has been stronger than expected and the inflation backdrop and near-term outlook are much less favourable than was the case three months ago. In addition, there is uncertainty about the stance of monetary policy and this year’s rate reductions are yet to fully flow through.

Our sense is that it won’t take much for the RBA to respond to evidence of a more persistent inflation trajectory. For now, we see the RBA on hold next year, but risks to the outlook are clearly asymmetric. February is now a live meeting should forthcoming inflation data on 7 and 28 January validate the RBA’s fears.

Unattributed votes

The Statement noted that today’s decision was unanimous.