The RBA looks like it's running out of ideas, and hope appears to be the plan

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  • The Reserve Bank of Australia says it should be seen as a “source of stability and confidence”.
  • It is forecasting that stronger economic growth will help reduce unemployment and lift inflation and wage pressures, but it’s said that regularly since the GFC.
  • This is arguably weighing on, rather than adding to, confidence levels.

The Reserve Bank Of Australia (RBA) has three clear policy mandates.

It is to exercise its powers to best contribute to stability in the Australian dollar, maintaining full employment and delivering economic prosperity and welfare to Australians.

However, following the release of the bank’s May monetary policy minutes, it now appears that it has an unspoken mission: to be a source of confidence.

Here’s the key final paragraph from the minutes in which the RBA discusses its considerations for monetary policy. Our emphasis in bold.

Members agreed that it was more likely that the next move in the cash rate would be up, rather than down. As progress in lowering unemployment and having inflation return to the midpoint of the target range was expected to be gradual, members also agreed that there was not a strong case for a near-term adjustment in monetary policy. Rather, members assessed that while this progress was unfolding, it would be appropriate to hold the cash rate steady and for the Reserve Bank to be a source of stability and confidence.

“A source of stability and confidence”.

On the surface, it’s not an usual statement by any means.

By being predictable about the expected path for interest rates, it will allow households and businesses to prepare for what potentially lies ahead.

However, official interest rates currently sit at the lowest level on record, and what that indicates is anything but confidence building.

The RBA hasn’t lifted official interest rates since late 2010. Instead, it’s been cutting them, seeing the cash rate fall to 1.5%, the level it has sat since August 2016.

This elongated easing cycle, coming in fits and starts, suggests the economy has been anything but strong over the past seven years.

Inflation is low, as is wage growth, and unemployment is still elevated at 5.5%, suggesting the economy has been running below its full potential for the vast bulk of this period.

While offshore factors have played a role, especially in growth handover between China and the United States following the global financial crisis, things haven’t improved all that much in recent years despite official interest rates remaining at levels never seen before.

Economic growth remains sluggish, inflation is weak and unemployment is high.

Not exactly confidence-building, right?

Only last month, RBA Governor Philip Lowe talked about what interest rate settings indicate for how the economy is progressing, noting that when they are increasing, it’s generally a sign that things are improving.

“It is worth remembering that the most likely scenario in which interest rates are increasing is one in which the economy is strengthening and income growth is also picking up,” he said.

That’s the kind of scenario one would expect would lead to increased confidence levels.

However, now, confidence will be helped by ongoing stability in the cash rate, hinting that it could remain at current levels for even longer than many expect.

Rates rising or rates being held at the lowest level on record for potentially another year, maybe more, indicating the economy is not strong enough to cope with even a tiny increase in borrowing costs.

What scenario breeds confidence? A stronger economy or a weak one?

Of course, while the economy is not strong enough now to deal with higher official interest rates at present, the RBA, as it has done so for umpteen years, expects that scenario will change in the years ahead, predicting again that faster economic growth will eventually lead to a gradual reduction in unemployment which, in turn, will lead to a gradual lift in wages and inflation.

However, as pointed out by Credit Suisse earlier this year, the RBA has predicted this before on numerous occasions only to end up disappointed.

“The RBA has become renowned over the years for delivering hawkish and arguably credible narratives, supported by consistent upward inflection points in its growth and inflation forecasts, virtually dismissing near-term undershoots, resulting in consistent over-prediction of real GDP growth and core CPI inflation,” analysts at the bank said in a note released earlier this year.

Given that track record, Credit Suisse said the RBA’s credibility is slowly being eroded by being consistently optimistic.

Like the boy who cried wolf, this runs the risk of a creating a scenario where nobody believes that the economy will improve even though the RBA says it will, amplifying the challenge to get households and business to invest and spend to deliver stronger growth.

While the RBA still has plenty of credits in the bank having guided Australia to 27-years of uninterrupted growth, if recent trends are maintained in the period ahead, it will do little to build confidence, even with stability and predictability in interest rates.

It will be quite the opposite, in fact.

Callam Pickering, Economist at employment specialists Indeed, also thinks the RBA’s recent actions might actually be detracting, rather than adding, to confidence across the Australian economy right now.

“It should come as little surprise that the RBA views itself as a ‘source of stability and confidence’. Their forecasts are mainly designed to manage expectations rather than describe a plausible future,” he said on Twitter following the release of the RBA minutes.

“The underlying belief is that the power of positive thinking is sufficient to push the economy in the right direction. They believe that forecasting growth of more than 3% makes it more likely that it will happen.

“It’s been like this for a number of years now. No matter what the cash rate is the RBA has an unwavering belief that the economy is merely a year or two away from growth being above trend and inflation being just right.”

As such, Pickering says recent policy inaction from the RBA is “a sign of a central bank that believes it is out of options”.

It won’t cut interest rates to help stimulate demand, perhaps concerned about what it could do to house prices and household debt levels given what happened in 2016 and 2017, and choosing instead to hold tight and hope that things will eventually fall into place.

We all hope they will, but should the economy not pick up even with stability in interest rates, something will have to give and the RBA will surely have to assess its policy options to see the growth rates it has long been promising come to be.

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