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The big picture: two large, overlapping shocks and a very significant monetary policy response

This week

A busy week in Australia, with Q2 GDP, the RBA’s September Board Meeting and the NAB/Anika Foundation Speech by the RBA Governor on Thursday (link for customers to attend at the end of the main article). NAB expects the fourth successive 50bps interest rate increase to be announced on Tuesday as the RBA moves policy back to a more neutral level. Thereafter, we expect smaller 25bps increments in cash rates as rates move above neutral into a slightly restrictive setting of 2.85% by November, at which time we expect the RBA to hold rates at least until February, as it assesses the impact of previous tightening, given the known lags in policy.

While GDP is forecast by the market to have grown 1% in Q2 (NAB +0.7%), the data is very dated given the significant policy tightening in June, July, August and in prospect tomorrow. Much more interest will be in the Governor’s Inflation and the Monetary Policy Framework Speech on Thursday. Here we’d expect the Governor to remain hawkish/committed to doing whatever it takes to return inflation to the target band, but to remind that Australia’s flexible inflation target means the RBA will seek to do that over a period of time (1-2 years) rather than extremely rapidly. That would seem wise given the significant uncertainties related to some of the effects of COVID, that continue to impact economies (for more details see our What to Watch publication).

Analysis

In our feature piece, we outline how the economic outlook and business conditions are being shaped by COVID, Russia’s invasion of Ukraine and the resultant significant monetary policy response being enacted by central banks. While there have been some encouraging signs of a modest reduction in supply chain disruptions and goods pricing in the US, the energy shock from Russia’s invasion of Ukraine and tight labour markets, mean that it’s too early to expect a significant easing in services price pressures.

While the need to tighten policy is clear, it is still not clear the extent to which the supply shocks we have seen are permanent. And if they are, whether it will constrain the ability to produce goods and services without generating inflation. If these constraints exist, a prolonged period of demand growth being below potential may be needed as central bankers signalled at Jackson Hole, and no early easing in policy is likely.

Central banks will need to be careful not to overtighten given the lags in monetary policy. And businesses, similarly, will need to consider inventory levels as the aggressive monetary policy tightening being implemented should see further moderation in demand – especially for the interest-sensitive sectors of the economy such as housing and durable goods – which should further assist in reducing supply chain disruptions and elevated freight and goods pricing.

But given tight labour markets and the ongoing flow through of elevated energy prices globally, a more general easing in inflationary pressures is more likely to be a 2023 story, than to be significantly evident in the published data this year. In this context we remain sceptical of markets pricing in interest rate cuts in 2023.

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