Former top RBA official says it risks falling into persistent policy error

Australia Broadcast Center

3 days ago

Millions of mortgage borrowers are not the only ones disappointed by the Reserve Bank's decision to not cut interest rates this month.
Former RBA assistant governor Luci Ellis, who is now Westpac's chief economist, described the decision — by a six-to-three majority of the monetary policy board — to wait before cutting rates again as "uncharitable".
Westpac and its customers rely on her interpretation of what the Reserve Bank Monetary Policy Board will do with interest rates from meeting to meeting.
And, although she suspected the Reserve Bank might wait until August to cut interest rates again, she still switched her forecast to a July interest rate cut after weak monthly inflation figures were released by the ABS a fortnight ago.
"One of the reasons I [originally forecast the next interest rate cut in August] was a sense that … they would wait, thinking that they wouldn't use the full information set available to them now," she explained.
In other words, Dr Ellis assumed the Monetary Policy Board would wait for the more comprehensive June quarter inflation data before cutting interest rates.
"It felt a little bit uncharitable [to forecast that]," she said.
However, the majority of six opted for a cautious approach, waiting for that more detailed data to confirm that inflation was falling in line with the Reserve Bank's forecasts, which have it hitting 2.6 per cent — close to the mid-point of the 2–3 per cent target.
In a LinkedIn post late on Tuesday, Dr Ellis expressed some frustration over the RBA's decision to leave the cash rate unchanged.
"Why on earth wait?" she wrote.
In the post-meeting statement, the RBA explained that "the board judged that it could wait for a little more information to confirm that inflation remains on track to reach 2.5 per cent on a sustainable basis".
However, Dr Ellis found that explanation unconvincing.
"I think it was quite an unconfident call by the RBA not to move this time," Dr Ellis said.
"Unless they really think they might not move in August, it wasn't clear why [the RBA] didn't already have enough information to make that decision."
The Reserve Bank Monetary Policy Board said it would "be attentive to the data and the evolving assessment of risks to guide its decisions".
"In doing so," the board said, "it will pay close attention to developments in the global economy and financial markets, trends in domestic demand, and the outlook for inflation and the labour market."
The next ABS Labour Force data will be published on July 17, while the June quarter CPI data will be released on July 30.
But Dr Ellis argued the RBA was focused almost exclusively on the quarterly inflation data.
"This has been the rounds that we've been on for the last 18 months," she lamented.
"It shouldn't, in some sense, come down to one number, but each quarter it has.
"I mean the number of times that our [interest] rate calls have hinged on [the question], 'Was there a surprise [in that CPI data]?' — it's kind of a clunky way to have to make your [interest] rate forecasts.
"But on the other hand, they're at the point where they're trying to work out if inflation really is comfortably inside the 2 to 3 per cent target range, whether it's going stay there, whether it's going to get to that 2.5 per cent [inflation] rate."
Dr Ellis believed that was not the best way to make monetary policy decisions.
"It's going to keep coming down to the quarterly CPI, and it will mean that people focus so much on that number instead of on the broader assessment of the economy," she cautioned.
"And that's a shame."
Investment firm, Deutsche Bank, similarly took aim at what it perceived as contradictory language in the RBA's communications.
"The [RBA's] post-meeting statement notes that: 'While recent monthly CPI Indicator data suggest that June quarter inflation is likely to be broadly in line with the forecast, they were, at the margin, slightly stronger than expected,'" chief economist Phil O'Donaghoe noted.
"We struggle to interpret what the RBA means with this phrase.
There were a few economists, however, who anticipated the central bank's decision to leave interest rates unchanged.
Betashares chief economist David Bassanese was one of them.
"As I have consistently argued in recent weeks, the case to cut rates today was never compelling," he noted.
"While consumer spending remains stubbornly weak, the labour market remains strong.
"And while the recent monthly CPI report showed a large decline in annual trimmed mean inflation to 2.4 per cent, monthly reports are notoriously volatile.
"Only the month prior, trimmed mean annual inflation was at 2.8 per cent."
Underlying inflation at 2.8 per cent indicates price growth more broadly in the economy could easily move outside the RBA's 2 to 3 per cent comfort zone.
"To my mind," Mr Bassanese added, "the RBA [will] wait for the more reliable quarterly CPI report later this month to confirm a decline in underlying inflation before cutting rates again in August."
Dr Ellis, however, argued this approach could push the RBA into chronic policy error.
"I think where there is a risk partly around the idea that maybe the RBA is seeking so much certainty in the data that they end up continuously behind the curve more generally," she warned.
"So if it forms into a pattern of behaviour where the RBA doesn't have the courage of its analysis, isn't willing to make a forecast that is anything other than locked in based on backward-looking data, that would be a problem.
"But it's not what we're seeing yet."