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• We noted in a prior Weekly the RBA’s pivot towards maximum sustainable employment, which in short is the highest level of employment consistent with inflation being sustainably within the RBA’s 2-3% target band.
• The implications of that pivot are reactive, rather than pre-emptive rate hikes, with Governor Lowe having pledged not to hike rates until actual inflation is sustainably within the 2-3% target band, with wages growth of 3%+ key to that assessment.
• What is less clear is what this policy means for forward guidance, particularly when the labour market is improving much more quickly than expected. The uncertainty is mainly due to the RBA’s dual basis for such guidance, with calendar-based guidance courtesy of the RBA’s 3yr yield target, and outcomes-based guidance in that inflation needing to be sustainably at 2-3% for a rate hike.
• While outcomes-based guidance is unlikely to change, the RBA will need to decide whether to extend its calendar-based guidance – whether to extend 3yr YCC from the April 2024 bond to November 2024 bond. The RBA has said it will pay “close attention to the flow of economic data and the outlook for inflation and employment”.
• NAB’s view is that the RBA will not extend the target as the RBA will not be able to confidently say rates will be on hold until late 2024 given the sharp labour market improvement.  The unemployment rate at 5.6% is already running almost 2 years ahead of the RBA’s forecasts, while April JobSeeker numbers have 93k less people on unemployment benefits in April despite the end of the JobKeeper program! While it is unclear how this will be reflected in the unemployment rate, a decline of that size in unemployment would be enough to drop the unemployment rate to 5.0%. To put that into context, that would bring the unemployment rate closer to model-based NAIRU estimates (Treasury’s recent NAIRU estimate is around 4.5-5.0%).
• While NAB doesn’t put much faith in model-based NAIRU estimates (and Governor Lowe has said NAIRU could be in the low 4s), the risk is that wages pressure emerges sooner than expected as unemployment approaches model estimates of the NAIRU, especially considering underemployment is now below pre-pandemic levels. This should be enough for the RBA to envisage and indeed forecast core inflation being at 2-3% in 2024. NAB’s forecasts sees unemployment at 4.4% and wages growth of 2.8%  by end 2023, with core inflation at target in 2024.

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