RBA does not do forward guidance - HSBC

In contrast to other central banks, the Reserve Bank of Australia does not give explicit forward guidance and this practice stems from the RBA’s month-to-month approach to monetary policy, explains Paul Bloxham, Chief Economist at HSBC.

Key Quotes

“At each board meeting, the RBA is not setting out a path for policy but, rather, determining if the current cash rate setting is appropriate. Unlike some other central banks, the RBA explicitly admits that it does not know what it will do with its policy rate in six, twelve or twenty-four months’ time.”

“The RBA has deemed that, by publishing a particular path for the cash rate, it could be giving undue weight to that particular path. The RBA thus seems more willing than other central banks to state that there is considerable uncertainty in forecasting.”

“The RBA indicates the unpredictability of the situation in each of its quarterly official statements. Here, it publishes forecasts with confidence intervals based on the central bank’s own historical forecasts. These error bands are enormous.”

“Given this quantum of uncertainty around the growth forecasts, one can only imagine the enormous uncertainty that would exist around a published path for the policy rate.”

“For the Australian economy, where the shocks largely come from abroad and can often be driven by very volatile commodity prices, the risk is that publishing a policy path would more likely be ‘forward misguidance’.”

“This is important background for understanding the reaction, during the past couple of weeks, to the RBA’s monthly board minutes published on 18 July. Specifically, the board minutes revealed that the board had discussed the neutral cash rate for Australia, which the RBA staff estimate at around 3.50% – 200bp higher than the current cash rate setting. The mere mention of this saw a large market reaction, pricing in a shift in the next rate hike from late to early 2018 and the AUD rallying.”

“This week’s board statement continued with a ‘neutral’ tone, with no hints that the RBA could lift rates anytime soon. That doesn’t mean it couldn’t happen; it’s just that the RBA is not going to say so in advance.”

“Rather than focusing on what the RBA says, the key is to watch the economic indicators. Indeed, our central case is that the RBA will lift its cash rate in early 2018. By then, we expect that local growth will be running at an above trend pace, that underlying inflation will back in the 2-3% target band, and that Sydney and Melbourne’s housing markets will still be uncomfortably exuberant. Come early 2018, this should give the RBA little reason to keep its highly accommodative cash rate setting.”