Earlier this month, the Reserve Bank (RBA) reverted to its old practice of providing guidance, with the governor pushing against market pricing for an interest rate reduction by the end of 2024.
Michele Bullock said, “it is premature to be thinking about rate cuts” and “a near-term reduction in the cash rate doesn’t align with the board’s current thinking”.
Economists were caught off guard by the central bank’s decision to reintroduce forward guidance, especially after the RBA’s 2022 review, which followed Philip Lowe’s misjudged prediction that “a hike is unlikely before 2024”.
While the review concluded that “in most situations, the preferred approach is to let markets and the public infer the timing and extent of future interest rate movements”, Bullock has repeatedly indicated that a near-term rate reduction is unlikely, defining “near-term” as “by the end of the year and the next six months”.
Bullock has, however, on occasion prefaced her rate-related comments with the words “no forward guidance”.
Commenting on the governor’s unexpected return to speculative forecasting, CBA’s head of economics, Gareth Aird, said: “In our view, that is forward guidance”.
“Forward guidance, as it refers to monetary policy, is simply communication about central bank intentions for future monetary policy.”
Pointing to the board’s most recent minutes, Aird said several contrarian statements were made, including that the cash rate is unlikely to decrease in the short term and that the board is not committing to any specific policy direction.
Moreover, Aird noted that the board’s vow to remain data dependent also sits at odds with forward guidance.
“History shows that data-dependent central banks will change their tune or ‘pivot’ if the data makes the case. That’s a good thing. There is no need for a central bank to be dogmatic about the future direction of monetary policy if the economic landscape is evolving differently to their forecasts,” Aird said.
“Central banks should be agile. And in many respects that is why forward guidance is often not a good policy option.”
This mixed messaging and a distrust of the bank’s forward guidance has seen markets maintain their rate expectations – pricing in a full 25 basis points interest rate cut by the end of the year.
According to Aird, CBA continues to side with market pricing.
“[We] think it more likely than not we will see an interest rate cut by the end of the year,” the economist said.
While chief economist Shane Oliver maintains that the risk of a cut by year end remains high, after the higher-than-expected May inflation data, AMP now expects the first rate cut to occur in February next year.
This decision was made on the grounds that “we don’t think the RBA would be confident enough to start cutting until then”, Oliver said.
“In fact, I think they should be moving to cut, which is of course different to what I think they will do,” he told InvestorDaily.
Oliver explained that the experience in other countries highlights how quickly things can change.
“Earlier this year, some at the Fed were talking about rate hikes and no cuts this year and back in May, the RBNZ was thinking of cuts. Now the RBNZ has cut and has turned dovish and the Fed is almost certain to cut next month. All it took in both countries was slightly lower inflation and weaker economic data,” Oliver said.
“Weaker economic data globally will weigh on Australia and, in any case, just as Australian inflation and interest rates lagged on the way up in 2022, they are now doing the same on the way down so there is no reason to see why we will be significantly different to other countries that are now cutting or moving to cut interest rates.”
Oliver believes there is a “very high risk” of Australia seeing similarly weaker economic data and inflation over the next few months.
“When the facts change so do central banks. Just as we saw back in 2022 when the RBA went from ‘no hikes till 2024’ to lots of hikes after inflation and the economy surprised on the upside,” the economist said.
Regarding the bank’s forward guidance, Oliver said he, too, is surprised given the central bank seemingly swore off it after the 2021–22 experience and the damage that caused to its credibility.
However, he opined, that notwithstanding the guidance, “the RBA would also quickly pivot to earlier rate cuts if the economic data warrants it”.
Ultimately, he noted “the difference between the RBA and market view on rates reflects different expectations for the economic outlook”.
