Reserve Bank continues to fret about looming fiscal cliff

Tapering, shmapering.

Yesterday, ahead of the first Reserve Bank (RBA) board meeting of the year, we wondered how the Bank would resolve the tension between an economy recovering better than expected/feared, which in other circumstances would necessitate some tapering of monetary policy support, versus the looming impact of the government’s cut-off of fiscal support, especially on demand.

At 2.30pm yesterday we got our answer: the RBA is worried that the government’s cut-off will seriously affect demand, meaning the economy will need all the support it can be given, especially when the JobKeeper and JobSeeker subsidies end. The only tapering the RBA is interested in at the moment is how quickly the government is going to pull support out from under workers and businesses.

Or as governor Philip Lowe explained it “an important near-term issue is how households and businesses adjust to the tapering of some of the COVID support measures and to what extent they will use their stronger balance sheets to support spending”. It will be up to people who lose JobKeeper or JobSeeker to call on their savings to keep consumption and demand growing in the face of a contraction in fiscal policy.

And instead of flagging — as some had predicted — that its timetable of three years until any lift in interest rates would be ditched, the Bank doubled down on it:

The board will not increase the cash rate until actual inflation is sustainably within the 2 to 3% target range. For this to occur, wages growth will have to be materially higher than it is currently. This will require significant gains in employment and a return to a tight labour market. The board does not expect these conditions to be met until 2024 at the earliest.

Ah… wages growth. That key element in the lives of working Australians that the government and business (along with much of the commentariat) refuse to ever speak about, because they have deliberately trashed it and continue to look for ways to undermine it.

The RBA, which has its own sorry record on the subject, is more open about it. On Friday it will reveal its latest forecasts in the February Statement of Monetary Policy, but yesterday’s meeting statement provides a preview (and Lowe has a speech this afternoon that will also provide some detail). “Wages (as measured by the Wage Price Index) are increasing at the slowest rate on record. Both inflation and wages growth are expected to pick up, but to do so only gradually, with both remaining below 2% over the next couple of years.”

The Bank can’t see inflation anywhere on the horizon. “In underlying terms, inflation is expected to be 1.25% over 2021 and 1.5% over 2022.” The Bank’s target range is 2% to 3% over time and the RBA wants to see inflation well into that range on a sustainable basis before it considers an increase in interest rates.

That’s not to say the economy isn’t doing well given the pandemic. “The economic recovery is well under way and has been stronger than was earlier expected … The recovery is expected to continue, with the central scenario being for GDP to grow by 3.5% over both 2021 and 2022.”

That is, by the way, short of the 3.75% growth Morrison committed to last year, another subject that has vanished from economic debate. But anyway, “the economy is expected to operate with considerable spare capacity for some time to come”.

As a consequence the Bank is committing an extra $100 billion in spending to support the downward pressure on the 10 year bond rate. The Bank has had sufficient success in its yield curve management of the three year bond rate — Lowe noted it has not needed any more purchases for two months because the market now believes that interest rates will be left unchanged at the current level for at least three years. But it is determined to push the 10 year rate — which will help put some downward pressure on a dollar fuelled by high commodity prices and our massive current account surplus.

The economy overall is looking solid, but for the actual people whom — theoretically — the economy is supposed to serve, years of higher unemployment and zero wages growth still lie ahead.