RBA Lists Inflation Expectations, General Psychology Shift As Key Uncertainty

--Underlying inflation forecast to peak at 6% end-2022, 3.8% end-2023, 3.0% end-2024
--Forecasts assume 3% cash rate end-2022, decline little by end-2024
--Inflation expectations, general inflation psychology shift are uncertainties for inflation outlook
--Slowing housing market represents a headwind for household consumption
--Unemployment rate could fall further than forecast

By Sophia Rodrigues

(Sydney, August 5, 2022)—The Reserve Bank of Australia’s forecasts are based on the cash rate rising to 3% by the end of 2022 and declining a little by end-2024 but uncertainties in the forecasts suggests the risk may be to the upside.

In the quarterly Statement on Monetary Policy, published Friday, the RBA raised the near-term outlook for underlying inflation with an expected peak of 6.0% in late 2022. This is up from 4.6% forecast in the May SOMP.

The RBA expects the economy to grow strongly over 2022 and slow in 2023 to below most estimates of potential growth. The unemployment rate is expected to decline to around 3.25% in late 2022 before rising gradually thereafter, in line with slower growth in activity.

The RBA listed the effect of high inflation and cost-of-living pressures on wage and price-setting behavior and inflation expectations as a material risk to the inflation outlook.

Higher expectations of future inflation could lead to a broadening of second-round price increases by firms, leading to higher actual inflation, the RBA said. Related to this, it noted that retailers have indicated in liaison that they are now more willing to pass on input cost pressures to consumers, rather than accepting lower margins.

It also noted that higher inflation outcomes are a factor in some current wage negotiations and could contribute to a pick-up in wages growth in the period ahead.

On the outlook for household consumption as a source of uncertainty, the RBA said persistently strong demand for labor could result in sustained momentum in household consumption. Spending would also be stronger than anticipated for a time if households are more willing to spend from their liquid savings from other forms of wealth, the RBA said.

And if domestic demand was stronger than expected, it would see domestic inflation pressures build further.

On the other hand, the RBA said consumer spending may fall more sharply for households with low savings buffers and high debt relative to incomes. Consumption growth could also be weaker than anticipated in response to larger-than-expected falls in housing prices or other asset prices.

With regards to labor market, the RBA said it is difficult to know how labor market dynamics and wage and price pressures will evolve as measures of labor market spare capacity decline to the lowest levels in several decades and participation rate remains at historically high levels.

The RBA said it is plausible that unemployment rate falls even further than forecast. But it also added that it could drift up towards the end of the forecast period as growth in activity slow and the cost of labor increases.

The RBA’s forecasts assume that further out in the forecast period, growth in consumption would slow as rising prices and higher net interest payments weigh on real disposable income growth, and declines in housing prices lower net household wealth. The household saving ratio is expected to decline over the forecast period to just below its average level in the years prior to the pandemic.

On the reopening of the international border earlier this year, the RBA said immigration could help to alleviate labour shortages in some industries over time, while also adding to demand in the economy

--Contact: Sophia@centralbankintel.com