Earlier this month, the Reserve Bank left the interest rate unchanged at 4.25 per cent, acknowledging that it is not ruling anything in or out given still stubborn underlying inflation and uncertainty around global events.
The RBA’s latest minutes, published on Tuesday, reveal that while the central bank believes inflation could return to its target in 2026, key factors could push it off course.
The central bank’s latest forecasts hinge on several critical assumptions, including a modest recovery in consumer spending. However, there are scenarios that could disrupt this outlook.
“Members recognised it was important to be ready to adjust the future stance of monetary policy as the economic outlook evolves. Members therefore considered the conditions that might warrant either a future change in the cash rate target or a decision to hold it at its present level for a prolonged period,” the bank minutes read.
Namely, if consumer sentiment remains weak or if consumption fails to pick up as expected, the central bank might consider cutting rates to spur demand.
Conversely, in the event that the recovery in consumption proves sharper than the forecast envisaged, resulting in higher-than-expected inflation, the RBA could be required to keep rates on hold for longer.
The labour market remains another crucial factor.
According to the latest minutes, members discussed scenarios where the assessment of the labour market turned out to be inaccurate, leading to conditions easing more significantly than expected. In such cases, a more accommodative monetary policy could be warranted. This, it said, might occur if firms are currently hoarding labour and are eventually prompted to reverse this strategy.
“Such trends were not yet widely apparent from the RBA’s liaison with firms, but members observed that if forward-looking indicators began to suggest a widespread easing in prospective labour market conditions and a more rapid easing in inflation, the board might need to consider a policy response.”
Alternatively, the RBA said that if its assessment of the economy’s current potential growth rate forecasts are too optimistic, or the economy’s supply capacity proves more limited than anticipated, this would necessitate a tighter monetary policy response.
It is also monitoring global risks, from US economic shifts to potential changes in Chinese policy, which could further complicate the outlook.
The RBA’s latest board meeting took place ahead of the US election outcome, but the board judged that regardless of the victor, US fiscal deficits were forecast to be large, making sovereign debt markets more sensitive to adverse shocks over time.
RBA becomes increasingly intolerant of high inflation
While the bank remains committed to its inflation target, the evolving economic conditions suggest that the cash rate could stay on hold for some time, but future decisions will depend heavily on how these factors unfold.
Ultimately, given the already lengthy period in which inflation had been above target, the board flagged its “minimal tolerance” to accommodating higher-for-longer inflation, even if this occurs because of factors that constrained the economy’s supply capacity.
“However, there were also scenarios in which inflation declined materially more quickly than currently forecast, perhaps in response to emerging signs that rental housing markets in many cities were moving into better balance or because the energy rebates have a more pervasive effect than factored in,” the minutes detailed.
While this could warrant an easing in the cash rate target, the board agreed on the need to observe more than one positive quarterly inflation outcome to be confident that such a decline in inflation was sustainable.
Members also noted that monetary policy might need to be adjusted if the board formed the view that the stance of policy was not as restrictive as had been judged.
“They agreed that it was important to pay close attention to potential signs of this, including developments in credit growth, banks’ willingness to lend and growth in asset prices.
“Returning inflation to target remains the board’s highest priority and it will do what is necessary to achieve that outcome,” it said.
