Steady as she goes: RBA holds to manage expectations

The Reserve Bank of Australia (RBA) held its policy rate steady at 4.35%, as widely expected. 

The Board acknowledged a gradual easing in inflation while noting that it still surpassed desired levels. Attributing easing goods price pressures to global supply chain normalisation, the Board highlighted persisting concerns over sticky services prices. 

The RBA anticipates inflation to align with the 2%-3% target range by mid-2026, while labour market conditions continue a gradual easing path, with wages remaining within the RBA's comfort zone pending productivity improvement.

Today’s decision and the hawkishness of the statement is in line with our expectations that the RBA would be on a watchful hold. Despite inflation trending downwards, we see today’s hold as a step to manage inflation expectations, a sentiment echoed by Governor Bullock in the press conference today. 

The reduction in the frequency of meetings underscores the importance for the RBA to exercise utmost certainty in its decisions, lest it undermine its credibility. Last year's review underscored the importance of clear forward guidance and effective communication, highlighting the stakes of any misstep. 

Exhibit 1: RBA Policy Path

Source: Reserve Bank of Australia (RBA)

We had previously underlined that rent and energy subsidies featured largely in the December quarter’s soft inflation numbers; therefore, it is not surprising that the moderation didn't sway the needle for the central bank. We expect the RBA to stay at a restrictive level until they are sure inflation momentum, especially in services, has weakened without fiscal stimulus. A clear cover in the form of consistently falling inflation towards its desired levels is what the RBA would be looking for before it considers a pivot.

Acknowledging global and domestic economic deceleration, the Board underscored Australia's subdued economic activity, primarily driven by strained household budgets and the resultant weak demand. Emerging disinflationary pressures across sectors reflect policy tightening gaining traction. 

Regarding the labour market, it’s been noted that firms are adopting stricter measures to control labour costs, resulting in a moderation of their plans for employment. 

Expectations around wages growth are also softer as elevated input costs continue to flow through some parts of the supply chain and business try to manage expenses. 

Consequently, labour market conditions are anticipated to continue easing, aligning more closely with full employment over the next few years. Nominal wage growth is forecasted to continue at its current pace in the short term before gradually moderating.

Exhibit 2: Revised forecasts       

The RBA highlighted the balanced nature of risks to the domestic outlook. On one hand, there's the possibility of demand softening more than expected, potentially hindering the attainment of full employment while dampening inflation. On the other hand, there's the risk of inflation taking longer than anticipated to reach target levels, which could pose costs to both employment and inflation objectives if it triggers upward shifts in inflation expectations.

The RBA is walking a tightrope.

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