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Analysis: RBA’s SoMP sees markets bring forward RBA pricing again

• Two important events occurred in markets last week. The first was a strong US Payrolls print, cementing expectations of a taper announcement at an upcoming FOMC meeting (September, November or December). As tapering becomes more certain, market focus will quickly change to the likely rate hike profile. Recent speeches by Fed Vice-Chair Clarida and Governor Brainard hint how this will evolve.
• The second event was RBA Governor Lowe’s Testimony and SoMP where an upbeat assessment of the economy despite lockdowns has seen markets bring forward RBA pricing. The RBA now forecasts core inflation of 2¼% by the end of 2023; within its band in its forecast horizon. The upside scenario sees inflation higher still at 2¾%.
• Both events have seen a strong market reaction with the US curve bear steepening (a rise in yields driven by the longer end), while Australian markets have brought forward their expectations of the RBA hiking rates back into late 2022. In this Weekly we expand further on the implications, and why for NAB while we see the risk of the RBA hiking in H2 2023, our view remains of early 2024. We also continue to see the RBA lagging the Fed, BoC and RBNZ in normalising policy.
• For the RBA, Governor Lowe in his Parliamentary Testimony has continued to emphasise the RBA wants to see actual inflation sustainably within target. That is, wanting to see “results on inflation before we move, not a forecast of inflation in the target range”. In assessing this condition, Dr Lowe noted “it will not be enough for inflation to just sneak across the 2 per cent line for a quarter or 2. We want to see inflation well within the target band and be confident that it will stay there”.
• Wages growth will also be important to that assessment. Although the RBA has yet to consider whether an overshoot of the inflation target to make up for the period of below target inflation is appropriate, Governor Lowe has indicated the RBA won’t respond aggressively to higher inflation, with inflation above 2½%, or even 3% for a time acceptable as part of the strategy to be confident that inflation is clearly on track to 2½%. Given the importance of the prospect of allowing an inflation overshoot to the rate hike profile, it is likely markets will be focused on this going forward.
• As for the US Fed, it is likely ‘substantial further progress’ will have been judged to have been made at an upcoming FOMC meeting (September, November or December), which would allow the Fed to make a tapering announcement. Market focus will shift to when we can expect the Fed to hike rates and when ‘maximum employment is achieved’. Based on the current trend payrolls pace then payrolls get back to pre-pandemic levels in February 2022 and back to where the pre-pandemic trend would have been by May 2022. The Fed of course is using a range of measures in assessing ‘maximum employment’.

Chart 1: Markets bring forward RBA pricing

Chart 2: Payrolls are now 5.7m below pre-pandemic

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