Reserve Bank Governor Philip Lowe (Image: AAP/Joel Carrett)

Next week’s budget will be presented in what will be the most propitious economic circumstances in years — according to the Reserve Bank of Australia (RBA).

This Friday will see the RBA release its second Statement of Monetary Policy for the year, and governor Philip Lowe yesterday gave us a preview with his post-meeting statement from the May board meeting. It suggests the most optimism issued by the central bank for more than a year — so much so that one key part of its groundbreaking monetary policy relaxation was all but terminated.

Friday’s statement will show sharp upgrades to growth and jobs forecasts for the next year or so, with inflation now seen a touch higher as well because of the faster pace of activity in the economy. The RBA now expects to see economic growth of 4.75% in 2021 (up from 3.5%) as well as an unchanged forecast of 3.5% in 2022, and an unemployment rate of 4.5% in late 2022, down from 5.5%.

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That rate means the RBA expects unemployment to be at what Treasury estimates is now around the non-accelerating inflation rate of unemployment (NAIRU) — though the RBA’s view is that it is lower than 4.5% — next year. That’s also, by implication, where the government is aiming fiscal policy after Josh Frydenberg’s welcome reversal last week.

What does that mean for wages growth and inflation? We’ll find out about wages growth forecasts on Friday, but the bank expects those to lift a little. As for inflation, that may peak at 3% (as Lowe has said previously) in the current June quarter then fall to 1.5% in 2021 and 2% in mid-2023 (that will be up from 1.75% as estimated in the February forecasts).

That suggests the RBA expects that even with the lowest unemployment in 15 years, a tight labour market will still struggle to feed through into wages growth and price rises. That means the Reserve Bank’s core inflation goal — to see inflation sustainably in its target band of 2-3% — still won’t likely be met until 2024.

But the AMP’s chief economist, Shane Oliver, said in a note on Tuesday afternoon that “given the speed of the recovery we think there is a good chance that the RBA’s objectives for a rate hike will be achieved before the ‘2024 at the earliest’ that it refers to and so are allowing for a first rate hike in late 2023. But that’s still a long way off. Key to watch will be unemployment heading to 4% and wages growth heading above 3.5%”.

Wages growth hasn’t been above 3.5% since Labor was in office, and after eight years of stagnation, that kind of figure looks implausible, especially with the government still punishing public servants with a real wage freeze.

But some tightening of monetary policy is already under way, with Lowe signalling in Tuesday’s statement that the provision of cheap funding to banks under the Term Funding Facility will end as scheduled in June. About US$100 billion has been lent already, and banks have the chance to access some of the second $100 billion between now and the end of June.

And the July monetary policy meeting is likely to see the RBA’s 0.1% bond yield target stay focused on the April 2024 bond rather than moving out to the November 2024 bond. That means the 0.1% target will “time decay” as the bond matures, preparing the way for a slow rise in market rates above 0.10%

The RBA will still consider future bond purchases beyond the completion of the current $100 billion bond-buying program in September. That could be kept but reduced (tapered) gradually from July onwards, perhaps to where it falls to half the current $5 billion-a-week rate at the end of 2021, then end in the June half of next year.

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Peter Fray
Peter Fray
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