02 Oct 2017
Monetary policy used to be a pretty simple policy lever. At least that’s the way I remember it. Inflation was the only policy target which mattered and inflation essentially tracked economic growth. In essence, the task of monetary policy was bounded by and focussed on cyclical issues.
That is no longer the case – but you wouldn’t know it when observing the commentary following October’s inflation data.
The data have been leapt on to argue the Reserve Bank of Australia is on hold, should stay on hold, and should recognise there are structural factors keeping inflation low.
"The task of monetary policy was [once] bounded by and focussed on cyclical issues. That is no longer the case.” - Richard Yetsenga
Certainly with core inflation annualising below the RBA’s target band and headline inflation having fallen back below 2.0 per cent, inflation is not sending an urgent signal about rate hikes.
If the hurdle for rate hikes is urgency around inflation, then there may not be a compelling case for a rate hike on any time horizon.
It has been very difficult – to say the least – to be forward looking about core inflation this cycle. A range of countries, over a run of years, have found core inflation has broken away from many of the standard tools used to calibrate and forecast it.
Core inflation is essentially driven by wages and margins (with a productivity underlay). Technology is pressuring both.
The vast majority of industry sectors, including services, are facing competition from technology-based new entrants.
These new entrants can add capacity very cost effectively – either because it exists already or because they are adding cheap digital capacity. This is changing the degree to which growth accrues to labour via stronger wages.
There are a range of indicators which suggest wage growth in Australia should rise somewhat over the next year or two. The experience of the bulk of other countries, however, even where labour markets are much tighter than in Australia, is that wage growth will rise a bit but then stabilise.
Moreover, business surveys have not been reliable in predicting whether sectoral skilled labour shortages might lead to wage pressure. In New Zealand, for instance, ANZ’s Small Business Microscope Survey has been suggesting significant skill shortages in the construction and services sectors for quite some time. Yet aggregate wage growth on some measures has actually declined.
Beyond these inflation-centric issues, the inflation outlook is no longer the only driver of monetary policy. In recent years the RBA tells us that financial stability has become a more important influence on policy.
That focus was clear in the most recent Statement on the Conduct of Monetary Policy in 2016 and has been reiterated in a number of the RBA’s public statements since that time.
Financial stability isn’t as significant as the inflation target in the RBA’s operational mandate. We haven’t seen the RBA either move interest rates or decline to move them primarily because of financial stability considerations.
That may change however with the household saving rate likely to be revised down to around 3.6 per cent for the second quarter of 2017, less than half its 2009 peak, and household debt at over 190 per cent of disposable income and still rising. So the debate over a broader policy target for the RBA needs to remain on the agenda.
The reality is the experience of inflation targeting globally presents an uncomfortable observation: every country with a pure inflation target has, or at least has had in the last decade, shown concerning levels of debt. In the US and UK the crisis revealed those problems. In countries like Australia, Sweden, New Zealand and Canada, they are more latent.
What’s to be done? Certainly moving further from the one instrument/one target basis for inflation targeting is not straightforward and could expose policy to conflicting influences at times.
But it seems increasingly necessary, and is all the more reason to use the window provided by the current firming in domestic and global growth to move interest rates off emergency settings.
In a world in which asset prices are already elevated and interest rate differentials unusually narrow, monetary policy operates primarily through the provision of credit. The pressure on macro-prudential policy, therefore, is unlikely to diminish as confidence around growth rises.
Inflation may give the RBA the cover it needs to hike next year. This would also make the policy environment more conventional. There is a strong probability, however, that inflation will only rise sufficiently to suggest the downside surprises have run their course.
We think that’s right, and it shouldn’t dissuade the RBA from its path. Rates need to rise in 2018. Growth is likely to be more evenly balanced, sustainable, and less aggravating for those trying to buy a home, with interest rates off the floor.
Richard Yetsenga is Chief Economist at ANZ
The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.
02 Oct 2017
24 Oct 2017