The Reserve Bank (RBA) is expected to hold its nerve on a soft landing in the economy, according to economists at NAB, despite stronger wages and higher underlying inflation.
NAB has predicted that the RBA will announce another 25 basis point (bp) hike at its first meeting of the new year next Tuesday, taking the cash rate to 3.35 per cent.
Important for the outlook, the NAB economists said, will be the RBA’s updated forecasts, which will be previewed in governor Philip Lowe’s post-meeting statement on Tuesday before more detail is provided in the next statement on monetary policy (SoMP) on 10 February.
“We expect the forecasts to continue to draw a path to a soft landing, but the characterisation of the risks will be key to determine whether the RBA continues to be confident that it can return inflation to target without pushing rates deep into restrictive territory,” commented NAB economist Taylor Nugent.
In its December interest rate decision, Mr Nugent opined that the RBA did not provide much guidance about the path forward. The RBA indicated that it considered a 50 bp increase, a 25 bp increase or no change in its December meeting minutes and reiterated that the board expects to hike rates further while not being on a pre-set path.
“But the addition of 0 bp in the discussion of options surely suggests the RBA sees a reasonable chance the data and outlook could make a case for a pause before too long.
“As a result, the SoMP in February will be key for the path of rates through the year,” said Mr Nugent.
“The RBA has been loath to move rates as aggressively as some advanced economy counterparts, seeing the inflation backdrop as more benign and the pickup in wages growth as moderate enough not to challenge a return to at-target inflation.”
Since the most recent SoMP in November, the NAB economists pointed out that annual trimmed mean inflation had risen to 6.9 per cent, above the RBA’s forecast of 6.5 per cent.
The fourth quarter wage price index (WPI), due out on 22 February, is also forecast by NAB to come in above the RBA’s expectations, with an annual lift of 3.5 per cent compared to the 3.1 per cent increase predicted by the central bank in November.
“While the RBA is likely to find good reason to expect that pace won’t persist, the wages outlook, and the risks around it, will be key,” Mr Nugent said.
“Labour cost sensitive inflation is running hot, and the RBA in November said the medium-term risks centred around the persistence of domestic inflationary pressures and the possibility that price- and wage-setting behaviour could shift.”
NAB expects the RBA will forecast a WPI increase of around 4 per cent by mid-year, as the recent acceleration in wages growth is more fully reflected in year-ended figures.
“We think there are good reasons for thinking peak labour market tightness is behind us,” said Mr Nugent.
“But there is little room for further upside to the wages outlook relative to expectations of the cash rate peaking around 3.60 per cent. The RBA will have to be more confident that the pace of wages growth will not lift further and will start to slow, and that wage- and price-setting behaviour is not threatening to shift higher.”
As for inflation, Mr Nugent suggested that the RBA will likely continue to see Q4 as the peak.
However, he argued that the RBA’s task is not to be confident that inflation has peaked, but to ensure that it falls back into its target band of 2 to 3 per cent within a tolerable time frame.
“The November forecasts saw underlying inflation and headline inflation still above the top of the target band at the end of the forecast horizon, at 3.2 per cent by December 2024,” Mr Nugent said.
“We expect the RBA will be able to forecast inflation back into the target band in the February SoMP, if only because the forecast horizon extends another six months to June 2025.”
Failure to forecast inflation returning to target over this timeframe, Mr Nugent added, would argue heavily in favour of a higher path for interest rates.
