Australia’s RBA review

Some change coming to the way the RBA does things following the independent review

22 April 2023 | Shane Oliver AMP Capital

  • The review notes that “Australia’s economic performance has been very good since flexible inflation targeting was introduced in the early 1990s” and “at least on a par with other comparable countries” and there is a broad consensus that the RBA has contributed significantly to this. Key recommendations are as follows:
  • Affirmation of the flexible 2-3% inflation target which “has generally worked well”, although it recommended the RBA’s objectives should be more clearly and equally defined around price stability and full employment.
  • Removal of the “on average, over time” reference to the achievement of the inflation target, which should be replaced with the RBA explaining “how it is using its flexibility”.
  • Affirmation of RBA independence and that it be strengthened with removal of the power of the Treasurer to overrule it.
  • The creation of a dedicated Monetary Policy Board from 1 July next year compromised of the Governor as chair, Deputy Governor and Treasury Secretary with 6 external members with expertise in macroeconomics, the financial system, labour markets and the supply side of the economy to set monetary policy. The Board would have formal votes with the 6 external members having the potential to override RBA official recommendations.
  • A move to 8 meetings a year to allow for better deliberation.
  • Press conferences after each meeting with an increased amount of information, and external Monetary Policy Board members publicly discussing decisions.
  • But it won’t change the RBA’s focus or what happens to interest rates. Looking at the key recommendations:
  • The RBA has already been targeting both price stability and full employment under Governor Lowe – which partly explains why it’s been less aggressive in raising rates than other central banks.
  • Its not clear that switching to regular press conferences and commentary from external Monetary Policy Board members will add much except more noise and potentially confusion around RBA decisions (as seen in other countries like the US) and the RBA already supplies a lot of information (maybe too much).
  • Removal of the “on average, over time” reference to the inflation target with the RBA explaining “how it is using its flexibility” may make the RBA less tolerant of short-term deviations from the inflation target and so could result in more aggressive and volatile moves in interest rates posing a greater threat to full employment.
  • Switching to less meetings may contribute to better quality decisions, but it may also make the RBA less agile, reduce “announcement effects” and necessitate bigger moves.
  • Having more monetary policy experts involved in the determination of monetary policy is a move in the right direction in being better able to challenge the RBA and add to its views.  It may at the margin help avert a rerun of some of the RBA’s missteps of recent years in relation to yield targeting and the “no rate hike till 2024” guidance, but having learned from that experience the RBA is unlikely to repeat them again anyway. The potential for external members to outvote the RBA members on the Monetary Policy Board could create confusion and actually reduce formal RBA accountability.
  • At a high level its questionable whether moving to the separate Monetary Policy Board, less meetings, more press conferences and more speakers model employed in several other countries is justified when those countries have not necessarily achieved better economic outcomes than the RBA.
  • Overall, the recommended changes if fully implemented are unlikely to have a significant impact on the outlook for monetary policy. In particular, there is nothing in the recommendations pointing to a less hawkish RBA that some may have been hoping for. Don’t forget that there are plenty of other central banks – in the UK, NZ, Canada and the US – that have separate monetary policy committees, less meetings and press conferences after each meeting, but which have actually been more aggressive and arguably less balanced in raising interest rates than the RBA has!
  • Should Governor Lowe be reappointed for another term from September? This is now a common question. He has indicated a willingness to serve for another term but of course the Government may opt for change. However, there is actually a very strong argument for him to remain. While with the benefit of hindsight the RBA has made some mistakes over the few couple of years, this is not particularly surprising given the wild swings in the economic outlook set off by the pandemic with most governments, central banks and economists being wrong footed at times. And Governor Lowe has learned from them and is most unlikely to repeat them. More importantly, the lessons of the 1970s – in particular the decision in the US to replace William Martin with Arthur Burns at the Fed – warn that its best to let Governor Lowe finish the job of bringing inflation back to target rather than seek a replacement who has to start anew in re-establishing confidence that the inflation target will be met. If Governor Lowe’s term is not extended there are plenty at the RBA who would be well placed to fill his shoes though including Michele Bullock, Luci Ellis and Christopher Kent.
  • RBA minutes incrementally more hawkish and point to a high risk of another rate hike next month but with a lot riding on March quarter inflation data. Continuing the pause on interest rates makes sense in our view as growth and inflation are likely to continue to slow and evidence of this will build in the months ahead, and not enough time has elapsed yet since the last meeting to assess the impact of rate hikes to date, eg, the last retail sales release was prior to the last RBA meeting and the next retail sales release won’t come until the day after the May RBA meeting. However, while the RBA looked like it was keen for a pause going into the April meeting, the minutes from that meeting suggest that it is strongly biased towards a further increase in interest rates, particularly with the minutes providing a strong case for another 0.25% hike and noting in particular concerns that stronger than expected population growth could add to housing costs and hence inflation and that there is now an increased risk of faster wages growth, including in the public sector. So while we expect March quarter inflation to be released in the week ahead to slow to 6.9%yoy for the CPI and 6.7%yoy for the trimmed mean (from 7.8%yoy and 6.9%yoy respectively) and this would support the case for a continuation of the pause which is our base case, this may not be enough for the RBA to head off another 0.25% rate hike. We think this would be going too far given that on the RBA’s own estimates 15% of variable rate borrowers will have negative cash flow by year end. A downward surprise on inflation in the week ahead as seen in other countries would add to the case for a continuation of the pause though. The money market is pricing in roughly a 20% change of a 0.25% hike in May, but an 80% chance by August.
  • So far so good with March quarter US earnings results. Only 17% of S&P 500 companies have reported so far but with 76% surprising on the upside which is far better than in the December quarter and in line with the long-term norm. The average beat is running at 5.6%.
  • Japanese inflation slowed to 3.2%yoy in March, although core (ex food and energy) inflation rose slightly to 2.3%yoy. Business conditions PMIs fell slightly but remained okay with the composite at 52.5.
  • China’s economy rebounding rapidly thanks to reopening.  Chinese Q1 GDP rebounded more than expected by 2.2%qoq/4.5%yoy with a much stronger than expected rebound in retail sales at +10.6%yoy. This is consistent with the rebound in mobility (eg, subway usage) and services conditions PMIs already reported. Property sales activity has also rebounded, and unemployment fell to 5.3%. Our 2023 GDP forecast remains +6% but this appears to be becoming consensus.

Australian economic events and implications

  • Australian business conditions PMIs for April saw a surprising bounce with services conditions up sharply but with new orders more moderate. Output prices ticked up slightly, but input prices fell further and both are well below their highs. Order backlogs are still negative and delivery times continue to improve. All of which remains consistent with easing inflation pressure. 
  • New home sales fell another 7.2% in March, contrary to other signs of an uptick in the property market, and are running down around 46% on the March quarter a year ago.