Well, as I expected, the RBA has hawked up something chronic and disappointed those who were hoping otherwise. And as they should: the downside risks to global growth and deflation (!?) are dissipating, while the upside risks have risen very substantially indeed.
All of the economists who shifted their first rate hike to end of the year are going to have to do a 180 degree turn, one way another. On the balance of probabilities, the RBA will be hiking before the end of Q2.
The RBA has come out thundering in today's Statement on Monetary Policy, which reveals an upgrade to its global growth forecasts, upgrades to its terms of trade projections, upgrades to its 2011 GDP forecasts, assumptions for growth in 2012 and 2013 that are well above market estimates of Australia's sustainable (non-inflationary) growth rates, and upgrades to its headline CPI forecasts for end 2011, which means they will be worried about positive drift in consumer inflation expectations (a near certainty in my mind). They have also published the same underlying inflation profile for year-ends 2011, 2012 and 2013, which possibly means, given the lower starting point care of downside surprises to inflation in Q2 through Q4 2010, inclusive, that the RBA is assuming a steeper core inflation path in the second half of 2011. As an aside here, it makes some sense for a central bank to over- rather than under-club its inflation forecasts to the extent that this communicates information about the hawkishness of policy.
One of the single most important variables for the RBA when thinking about Australian inflation is global economic growth. The RBA has materially upgraded its 2011 and 2012 expectations in this regard. As I have argued before, the prospect of having the no. 1 and no. 2 economies in the world firing on all cylinders at the same time as Australia is experiencing the largest national income and private investment shocks in post-war history will make setting monetary policy extremely tough.
And the RBA today assumes that the unemployment rate will not hit 4.5% until mid 2013. In reality, with rapidly slowing population growth, we could easily see a 4.5% unemployment rate in 2011. They also suppose that all of the positive price shocks on inflation that we are experiencing care of the floods and now Cyclone Yasi will have no impact on consumer inflation expectations. When you combine these shocks with an inexorably tightening labour market and almost-certain wage price pressures, this seems to be an exceedingly heroic assumption.
