Analysis: Actual and Forecast Inflation in RBA’s Amended Forward Guidance

By Sophia Rodrigues

The focus of the Reserve Bank of Australia’s amended forward guidance is actual inflation and hence the main message is that monetary policy will remain easy for longer.

But that doesn’t mean inflation forecast has lost its importance. What it means is that inflation forecast would become relevant at a later stage, not now.

Governor Philip Lowe explained the shift in the RBA’s forward guidance in a speech last week. Earlier Tuesday, Assistant Governor Chris Kent reiterated Lowe’s explanation in response to a question at the Q&A session.

The most important change is the RBA wants to see actual inflation in the 2% to 3% range.

Kent explained that underlying inflation moves slower than the headline inflation, so once the RBA sees underlying inflation in the range, it will look for confirmation that it is on the upward trajectory.

At that point, the focus will shift to inflation forecast and to see if inflation will be sustainably within the range.

There will always be some a degree of judgement involved but that process won’t begin until actual inflation is in the range, Kent explained

So, there are two parts to the RBA’s forward guidance

  1. The actual inflation has to be within the 2% to 3% range before the RBA would consider raising the cash rate target
  2. And it has to be sustainable and for that the RBA would need to see forecasts that show it would stay in the range for a good time.

(You may want to read my Oct 15 story on RBA's forward guidance for a full understanding of the shift. Please contact me for a copy).