What’s ahead for interest rates?
The Reserve Bank Board meets next week on February 1 and the Governor will be addressing the National Press Club on February 2 and the Bank will release its February Statement on Monetary Policy on February 4.
And the media and most investors are waiting with bated breath to hear what they have to say.
On January 20 Westpac surprised most analysts by forecasting that the first rate hike by the RBA will be announced at the August Board meeting.
The AFR released a “poll” of bank forecasters on the day of that announcement which showed: Westpac (August); CBA (November); ANZ (early 2023); NAB (mid 2023); and HSBC (late 2023) as the forecast dates for the first move by the various banks.
Now NAB have changed their view and see the first RBA rate hike occurring in November, with follow up hikes in December 2022 and February 2023
With the economy continuing to outperform and upside surprises to the labour market and inflation NAB now see the RBA beginning to normalise policy from November 2022.
The bank expects the first hike in the cash rate target of 0.15% in November (bringing the official cash rate to 0.25%), followed by hikes of 0.25% at each of the next two meetings taking the cash rate to where it was prior to the pandemic.
From there NAB expect a steady series of quarterly hikes – which would see the cash rate reach 2.5% by the end of 2024.
While economic activity will be impacted in the short term by ongoing virus disruptions, NAB do not expect the recovery to be derailed, with a strong rebound in Q2 and a growth of 3.6% overall in 2022.
More important for policy is the fall in the unemployment rate to 4.2% in December 2022 – around 6 months ahead of our previous forecast and 12 months ahead of the RBA’s November Statement of Monetary Policy.
Indicators of labour demand remain strong despite the disruption caused by the Omicron outbreak.
This suggests that upward pressure on wages growth will build over the next 6 months also – albeit with a recovery in migration providing some relief.
While still early days, a labour market that is tighter for longer will see wage pressures build more quickly than previously expected despite inertia in wage settings.
By November, NAB believes the RBA will have seen underlying inflation within (and potentially above) the target band for four successive quarters and have observed that the recent labour market gains have been sustained – we forecast unemployment will be below 4% by year’s end.
While the inflation outlook will remain uncertain at that point – as the impact of transitory virus impacts likely begin to wane – the RBA should have confidence that wage pressure will begin to flow through in 2023 and 2024 and thus sustain inflation at target say NAB economists.
In the near term, the RBA will continue to focus on actual rather than forecast outcomes, especially given the key uncertainties around ongoing virus impacts on activity and the speed and passthrough of a tighter labour market to wages and then inflation.
Therefore, NAB thinks the upcoming February SMP and Governor’s speech will emphasise a central case for rate hikes in early 2023, alongside a significant upgrade to labour market and inflation forecasts.
The RBA’s central wage forecast will likely be pushed to 3% in early 2023.
NAB Senior Economist Gareth Spence explained:
However, given the starting point for inflation, moving to a central forecast of early 2023 will necessarily mean earlier hikes if wages surprise the upside.
There is also the risk that the RBA’s tolerance for inflation overshooting the band may evolve depending on how high CPI prints in the interim.
Given the unexpected nature of the RBA’s prior two changes to its framework (maximum employment in late 2020 and YCC guidance in 2021), a change to more limited toleration for overshooting the inflation target cannot be ruled out.
In this vein, we should consider every meeting ‘live’ from August 2022.
If we take the RBA at their word, November is most probable with two more wages prints and three more inflation prints by then.
It is unlikely that the RBA will have had the opportunity to have assessed a broadening in wage growth and a flow-through to inflation before November.
On the other hand, if wage and especially price pressures start to moderate in the second half of 2022 the RBA may well form a view that the current upward surprises in price pressures were temporary.
As a result, there is a risk that the RBA start date is actually in 2023.
In any event, we do not see hikes occurring as rapidly as implied by current market pricing (110bps of tightening by December).
Ultimately, the key risks now lie around how quickly wages pick up in the absence of any further shocks to activity.
The experience prior to the pandemic suggests that unemployment around 5% implied significant spare capacity in the labour market with wage growth and short-term measures of inflation expectations softening.
Recent estimates by the RBA suggest unemployment of closer to 4% will be required for upward pressure on wage growth, though this is difficult to assess in real-time.
Further, inertia in the wage-setting process implies only a gradual pass-through to broader inflationary pressure and for the RBA to be forward-looking in setting a policy to move as early as November.
Offsetting this risk in the near term is the strength in demand and overall health in the economy which has seen firms able to pass on a degree of the supply-side cost pressures in play.
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