Market Strategist Evan Lucas explains why the RBA seems shackled to the policy fence.
At the start of the week I suggested the coming CPI data would provide framework for how the rest of the year could translate from a monetary policy point of view. It certainly didn't disappoint with that.
The reasoning for the ‘framing' statement is this; the core mandate of a central bank – the RBA being one of these – is to maintain underlying inflation between a certain target band. The RBA's target band is 2-3 per cent.
Q42017 CPI released on Wednesday showed that, for the fourth consecutive quarter, underlying (trimmed mean) inflation held at 1.8 per cent year-on-year. It missed the consensus estimates of 1.9 per cent; while technically in line with the RBA's estimate in its Statement of Monetary Policy (SoMP) of 1¾ to December 2017, it was still 20 basis points off the bottom of the band.
Headline inflation ticked up, and it is possible that headline inflation may move into the band over the coming year. However, the chart shows it is now nine consecutive quarters since underlying inflation was inside the RBA's target band. Drilling into the main components, there are no signs underlying CPI is materialising in the coming four quarters of 2018 for the following reasons:
- Ongoing weakness in wage growth
- Retail pricing
- Global growth translating into pricing power
With this CPI scenario as a base, it certainly leaves the RBA in a ‘fence sitting' position. Governor Philip Lowe and Co. at the RBA are trying to be hawkish on rates, flatly ruling out cuts with “the mostly likely moment in the cash rate being to the upside”.
However, without inflation materialising, the Board cannot even begin to frame the debate and/or communication on this path. With the next release of the SoMP due next Friday, which is likely to mirror the November release, its own forecasts preclude it from changing policy. It has clearly backed itself into a corner for 2018, and finally the market is agreeing with this prospect.
The interbank market was pricing in a 79.1 per cent chance of a rate hike by December this year leading into the CPI release on Wednesday. By Friday morning, at time of writing, this had fallen to 67.4 per cent. The bond market also responded in turn with buying, for the short-term yields to fall as the chance of a hike rescinded.
However, not every market has caught up with monetary policy story. The Australian dollar remained elevated and not far off the four-year high it reached late last week. Clearly though, the US dollar story remains the dominant theme.
All in all, this week's data has practically shackled the RBA hawks to the fence for 2018.
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