Economists expect the Reserve Bank will end its extraordinary monetary stimulus, upgrade its economic forecasts and potentially bring forward its interest rate guidance at Tuesday’s meeting, in a concession to financial markets convinced it will have to increase the cash rate this year to cool inflation.
The Reserve Bank holds its first policy meeting of the year in February and is certain to terminate its $350 billion bond purchase programme, conceived during the first outbreak of COVID-19, in a nod to the economic recovery.
Core annual inflation surged to 2.6 per cent in the December quarter, solidly within the RBA’s target band of 2 per cent to 3 per cent and well ahead of its timetable. Likewise, unemployment dropped in December to a 13-year low of 4.2 per cent, smashing the RBA’s projections.
The central bank will release on Friday the full suite of economic forecasts in the quarterly Statement on Monetary Policy. Governor Philip Lowe will speak to the media on Wednesday.
Bond markets have long wagered the central bank is behind the curve on inflation and needs to act. Interbank futures are fully priced for a 15-basis point move in May, with a chance in April. They point to a total of four increases this year, taking the cash rate to an implied 1.12 per cent by December.
Even so, the RBA has long argued that it will not raise the cash rate from the record low 0.1 per cent until inflation is sustainably in its target band, unlikely to occur until late 2023 or more likely 2024.
It said the tightening cycle here would lag other central banks which have started normalising policy because inflation and wage growth are at comparatively lower levels. For the RBA, wage growth is key, and it wants to see it rise to 3 per cent, from 2.2 per cent now.
The US Federal Reserve is preparing for a rates lift-off in March and the Bank of Canada is expected to follow. Meanwhile, the Bank of England and the Reserve Bank of NZ have already started to tighten policy.
But with the economy recovering at a faster pace than initially thought, speculation is mounting the RBA will have to back away from its dovish stance.
Capital Economics, Commonwealth Bank and RBC Capital Markets forecast a tightening in August.
“The governor is also likely to remain more patient than market pricing,” said Robert Thompson, macro rates strategist at RBC Capital Markets.
Marcel Thieliant, senior economist at consultancy Capital Economics, said inflation data made a good case for lift-off in May, but a federal election around that time made it unlikely.
“We suspect the RBA won’t hike in an election month and will need a bit more time to get accustomed to the idea that inflation will remain around its target even if wage growth hasn’t reached 3 per cent yet,” said Mr Thieliant.
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