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Why the RBA isn't making promises
Following a blockbuster inflation print, the RBA met on Melbourne Cup day and left the cash rate on hold as expected. With the decision obvious, the focus was on changes to the central bank's messaging. On this front, Governor Bullock confirmed that any further easing in the cash rate was not guaranteed.
A look at the Statement on Monetary Policy (SOMP), the RBA's quarterly report outlining their forecasts, gives more insight into their thinking. The central bank's forecasts for real GDP growth were little changed after adjusting for a slightly stronger than expected June quarter. Real GDP growth is projected to remain around 2% in 2026 and 2027, the maximum growth rate the RBA thinks the economy can handle without overheating. The labour market has been a little softer than expected recently, leading the RBA to lift its unemployment rate forecast by 0.1 of a percentage point to 4.4%. With the growth outlook steady and the labour market slightly weaker, the inflation outlook is the driver of the RBA's hawkish shift.
The near-term inflation outlook is notably higher, with underlying inflation (the RBA's focus) now projected to hit 3.2% by the end of the year and remain there until mid-2026. That is 0.6 of a percentage point higher than their August projections. However, the RBA sees this lift in inflation as temporary. Further out, underlying inflation is projected to be 2.6% at the end of 2027, just 0.1 of a percentage point higher than their August forecast.
Because monetary policy works with a lag, the RBA tends to focus on the outlook for inflation, rather than current inflation, when setting policy. Given that the inflation projection has lifted by only 0.1 percentage point to 2.6% why has the RBA changed its tune? There are three main reasons why the RBA is not promising to deliver any more rate cuts.
First, there is uncertainty about how much signal to take from the September print and so the RBA will need more time and data to be sure that the uptick in inflation momentum isn't sustained. The RBA has flagged that it thinks that there is more capacity (meaning inflationary) pressure than it previously thought and will be looking to carefully monitor this going forward.
Second, the RBA wants to reassure market participants that it is still aiming for the mid-point of its 2-3% target band, with Governor Bullock stating at the post-meeting press conference, "Just below 3% is not good enough for the Board". The RBA's higher inflation forecasts include the technical assumption of one more rate cut, and so not delivering that cut would likely push inflation to the mid-point of the target band, or maybe a little below it.
Third, the RBA is engaging jawboning - i.e. encouraging the market to take out expectations for rate cuts and similarly influencing household behaviour by re-setting expectations for policy. Relevant for the recent inflation print was the increase in housing construction margins due to stronger housing demand. The RBA will be hoping that its more hawkish messaging will take some of the heat out of housing demand, helping to contain inflation in this area.
Given the noncommittal messaging from the RBA, what would we need to see to get another rate cut? One path would be inflation momentum moderating a little more than the RBA expects. Market services inflation would need to ease and housing construction inflation steady in the coming quarters. In that scenario, the RBA would gain confidence that inflation was tracking towards target in a sustainable fashion. However, the size of the shock in September is large enough that the RBA would need to be quite confident about the path of inflation and even if the above conditions were met, would likely wait until the middle of next year to cut. The other path for a cut would be a sustained deterioration in the labour market, which drove a downgrade in the RBA’s inflation outlook.
Looking beyond the next year, the question becomes what level the cash rate will settle at once inflation is under control, also referred to as the neutral rate. The RBA has a suite of models that provide a wide range of estimates of the neutral rate, with some sitting above the current cash rate. The average of the RBA's models sits just below 3%, although commentary in both the SOMP and from the Governor indicate that the RBA believes the current cash rate to be only marginally restrictive. This implies the RBA expects that one more cash rate cut would take them to, or just below, neutral. There has been recent media attention on the potential for rate hikes. However, with the RBA viewing policy as restrictive, we see these concerns as premature and think the next policy move will be down.