Last week’s RBA press conference has, in our view, put it into an infinity spiral.
On one hand, it talks positively of the economic recovery, the ability for the nation to bounce back from lockdowns and circuit breakers and the surge in employment – most notably the slack that was once in underemployment and underutilisation is fast evaporating.
Then on the other, it talks about what needs to happen before it will even entertain rate normalisation. This being inflation inside its core band for 2 to 3 per cent for several quarters and wage growth averaging 3 per cent or more. Neither of these had been achieved in the past 5 years in the case of inflation and over 10 years in the case of wages.
Thus are we stuck in a never achievable spiral?
Let’s review further the main points of the press conference that feed into the points above:
1. “Full employment”- Lowe expressed a belief that full employment was probably in “low 4’s” and would need to stay at or below that level for a period of time. With the forecasts of gradual border re-openings full employment at ‘4’ is likely to be transitory as it will impact the employment/wages dynamic.
2. Core point around interest rates is wage growth. As mentioned above the last time wages growth was above 3% was 10 years ago and the bank doesn’t believe this level will be reached in the next 18 months. The core assumption is that without wages its inflation target won’t be met. Meaning until wages growth is above 3% there will be no confidence that inflation can hold up sustainably.
This is a core issue for the AUD in our opinion and one the market is picking up on.
3. The slight counter to the very dovish view on wages and its link with rats is that the pace of its QE program appears to be linked to forecast outcomes not just actuals. Couple that with this line from the press conference “Any increase in the cash rate will take place after bond purchases have ended. So, we have a ‘structure’ to the COVID-program unwind.
4. There was also a mention of a ‘flexible’ approach to programs, that a small change to the rate ‘notches’ could come about. But again, highlighted that they can’t see a path to rate normalisation before 2024.
We have been negative on the AUD for weeks, its failure to capture the $0.78 level off the back of amazing GDP, employment and iron ore data was a very bearish fundamental lead.
This has proven correct. However last week’s RBA meeting has given this fundamental lead another push and the $0.74 support looks to be under real pressure.
If the US data and recovery continues on its current path and Australia remains unable to move on policy the AUD is in for a tough few weeks and months.