RBA revises approach to forward guidance on interest rates

The Reserve Bank of Australia (RBA) has published findings from a review of its approach to forward guidance, undertaken in response to “extensive criticism” of its communications amid the period of COVID-19-induced weakness in economic conditions.

The central bank had suggested that it would not commence a monetary policy tightening cycle until 2024, following a period of aggressive easing at the height of the pandemic.

“The repetition of ‘2024’ in the bank’s communication served to create a strong anchor point, which held considerable sway in the public discussion of the bank’s intention for the timing of the first cash rate increase, even if financial market participants became increasingly sceptical about this time frame,” the RBA acknowledged.

“It was often interpreted that the RBA had promised that interest rates would not increase until 2024, with the statements about conditionality being downplayed.”

As such, the RBA conceded that the market would have been better served if forward guidance had provided a “less specific time frame, or one covering a shorter horizon”.

“Given that the outlook was highly uncertain, the board could have given more consideration to potential upside scenarios, including scenarios that could warrant the board raising the cash rate earlier than anticipated,” the central bank noted.

Off the back of its review, the RBA has committed to revising its approach to forward guidance to limit market confusion.

Changes include:

• Providing qualitative forward guidance, where appropriate: Focusing on the board’s policy objectives (particularly inflation and unemployment) rather than the drivers of these variables (e.g. wages), typically focus on the short term and be narrative in nature.
• Limiting forward guidance on interest rates but continuing to outline how monetary policy settings would be adjusted in response to evolving economic conditions.
• Avoiding publication of the RBA’s own forecasts of the expected monetary policy path.
• Considering a “stronger form” of forward guidance when policy rates are at, or near, the effective lower bound — providing flexibility and using scenarios to prepare for a range of possible outcomes.

RBA minutes tabled

The release of the findings from the RBA’s review coincided with the publication of minutes from the November monetary policy board meeting, in which the central bank lifted the cash rate by 25 basis points (bps) to 2.85 per cent.

Ahead of its decision, the RBA inflation “remained too high”, spurred by a number of global factors and “strong domestic demand” relative to supply.

“In view of the high current rate of inflation and the forecast for inflation, members agreed that a further increase in the cash rate was necessary to achieve a more sustainable balance of demand and supply in the Australian economy,” the board noted.

“Price stability is a prerequisite for a strong economy and a sustained period of full employment.

“The board’s priority is therefore to return inflation to the 2 to 3 per cent target range over time, while keeping the economy on an even keel.”

However, the RBA stated that the path to achieving balance was “narrow” and “clouded in uncertainty”, particularly in light of the global economic outlook which had “deteriorated in the months leading up to the November board meeting.”

The RBA concluded by stating the “size and timing” of future interest rate increases would continue to be determined by “incoming data and the board’s assessment of the outlook for inflation and the labour market”.

“The board remains resolute in its determination to return inflation to target and will do what is necessary to achieve that outcome,” the RBA added.

Lower than expected US inflation figures, released after the RBA’s November decision, have kindled hopes of a slowdown in a global revision to monetary policy settings.

The US Bureau of Labor Statistics reported core inflation of 0.3 per cent in October, down from a 0.6 per cent rise in September.

As a result, year-on-year inflation fell below market expectations (7.9 per cent) to 7.7 per cent, down from 8.2 per cent in September — the lowest annual inflation figure since January 2022.

But James Knightley, chief international economist at ING Economics, said he expects the Federal Reserve to continue hiking rates over the coming months, but acknowledged the October result would be “very supportive” of a “step down” from 75 bp increases to a 50 bp hike in December.

The November jobs report (to be released on 2 December) and the November CPI report (to be released on 13 December) would ultimately influence the central bank before its Federal Open Market Committee (FOMC) meeting on 14 December.

ANZ Research is expecting the Fed to lift rates by 50 bps in December before two 25 bp hikes in February and March.

This would take the federal funds rate to a “peak” of 5 per cent.

Hikes from the Fed are expected to influence the monetary policy decisions of other central banks, including the RBA.

AMP Capital chief economist, Dr Shane Oliver, is forecasting a 25 bp rate hike in December, with the potential for a “final” hike in February — taking the cash rate to the “low 3’s”.