RBA may move goalposts on inflation target
- Market firms on August AUD rate cut after release of RBA minutes
- CPI figures next Wednesday will be critical to the Bank's decision
- Inflation targets may need a rethink in current global climate
The Australian economy doesn’t need a rate cut. GDP is expanding around 3% per annum, slightly above potential, the unemployment rate is close to its natural level, exports are buoyant and the housing market is booming. The problem is none of this is feeding through into inflation and, like so many other central banks, the RBA is locked into an inflation-targeting straight-jacket, self-imposed in the 1990s and recently re-affirmed.
would likely miss. Photo: iStock
In the Statement of the Conduct of Monetary Policy signed in Oct 2013 “both the Reserve Bank and the Government agree on the objective of keeping consumer price inflation between 2% and 3%, on average, over the cycle. This formulation allows for the natural short-run variation in inflation over the cycle while preserving a clearly identifiable performance benchmark over time”.
That’s a narrow goal to be aiming at, one that even football aces Cristiano Ronaldo and Lionel Messi would probably miss “on average”. And Reserve Bank of Australia Governor Glenn Stevens is proving he’s no sharp-shooter. As the chart below shows, inflation has fallen below the 2%-3% target zone, whichever way you cut it.
Source: Reserve Bank of Australia
The downtrend is likely to continue next Wednesday when the June quarter Consumer Price Index numbers are released. The RBA doesn’t provide quarterly CPI forecasts but, judging by the projection made in its June Monetary Policy Statement that inflation will average 1.5% over 2016, we can infer they will be looking for a number close to 0.5% for the June quarter.
Adding weight to the argument in favour of an imminent rate cut is the recent rally in AUDUSD, which will add downward pressure to inflation in coming months. The minutes said “an appreciating exchange rate could complicate the necessary adjustments” the economy still has to make if it is to move away from dependence on the mining industry.
Source: Reserve Bank of Australia
The June forecasts had inflation averaging 1.5% in 2016, assuming “market pricing” for the future direction of interest rates. Market pricing at the time had the 1.75% policy rate down to 1.5% by August. So it can be argued that a cut on August 2 is a done deal because inflation at 1.5% would be under the RBA’s 2%-3% target zone. That would be the case even if next Wednesday’s update matched the Bank’s forecast.
There is some talk the Bank will instead take the opportunity to either widen the target to 1%-3% or extend the period within which the current target will be reached. The justification would be the economy doesn’t need a rate cut and slavish adherence to a narrow inflation target would do more harm than good. Certainly there would be precedents for extending the target achievement date: the Bank of Japan and the European Central Bank do it on a regular basis while the US Federal Reserve was careful not to lock itself into re-timing in the first place.
So it comes down to a call between delivering a rate cut the economy doesn’t need or moving the goal posts. Tinkering with the current Statement on the Conduct of Monetary Policy would not be done lightly and it’s probable the RBA would first float the idea, perhaps in the Monetary Policy Statement on August 5.
The newly re-elected government of Prime Minister Malcolm Turnbull would also have to be on board.
It’s an intriguing idea for Stevens’ successor as RBA Governor to consider in the future, but in the meantime monetary policy must be consistent with the self-imposed straight-jacket of 2%-3% inflation, a “clearly identifiable benchmark”.