Higher inflation should see the RBA revise up its outlook
History suggests that there is the risk that the RBA revises up its longer term forecasts of inflation.
The RBA next decides on interest rates when its board meets on 6-7 May, where it seems likely to drop its recently-adopted neutral view on interest rates and return to warning that it could raise rates given higher-than-expected underlying inflation and a more resilient labour market than the staff had forecast.
At that meeting, the board will rely on the staff's updated forecasts, which will be published on 7 May in the Statement on Monetary Policy.
CCI expects that the staff will revise up its outlook, factoring in higher underlying inflation, stronger employment and a slower forecast increase in the unemployment rate.
The near-term forecasts for underlying inflation should be bumped up because the Q1 outcome exceeded current RBA expectations and the trajectory of the monthly CPI plausibly suggests that Q2 inflation could do the same.
Importantly, history also points to a risk that the RBA raises its longer-term forecasts by about 0.1pp.
This risk is based on an analysis of the RBA's forecast database, where there is a weak positive relationship between the RBA’s forecast error for underlying inflation in the current quarter and the RBA’s subsequent revisions to forecast inflation in 1, 1½ and 2 years’ time.
Revising the RBA's forecast trajectory in this way might seem surprising, but, like the market, the RBA finds it hard to forecast inflation over the 1-2 year horizon relevant to policy and it is responding to what it regards as new information in the latest inflation figures.
The analysis also suggests that there is a possibility that the staff revises up the forecast for underlying inflation in mid 2026 from 2.6% to 2.7%, which would mean that the RBA was now taking until H2 2026 - which is just outside the staff's published forecast horizon - to return inflation to the 2½% midpoint of the 2-3% target band.
This would matter greatly because the updated agreement between the RBA and the government now states that, "The Reserve Bank Board sets monetary policy such that inflation is expected to return to the [2½%] midpoint of the target."
That agreement also noted that, "the appropriate timeframe for [meeting this objective] depends on economic circumstances and should, where necessary, balance the price stability and full employment objectives of monetary policy", but taking until the second half of 2026 to hit the midpoint would be at odds with the RBA repeatedly stressing that, "returning inflation to target within a reasonable timeframe remains the board’s highest priority".
Put another way, taking that long to return inflation to target would point to some risk that the RBA acts on a renewed warning that it could raise rates, unless, of course, inflation slows in Q2 and/or the labour market quickly weakens.
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Based in Sydney, Kieran Davies is Chief Macro Strategist at Coolabah Capital Investments, an asset manager with 40 executives and over $8 billion in fixed-income strategies. Kieran is responsible for macroeconomic research and investment strategy, contributing to the investment decisions of the firm. Kieran has long experience as a macroeconomist in both the private and public sectors. He has worked most recently as Chief Markets Economist for National Australia Bank and was previously Chief Economist, Australia and New Zealand, for Barclays Bank and ABN Amro Bank/RBS. Kieran also worked as Principal Adviser on the macroeconomy and budget policy in the Commonwealth Treasury and Director of Forecasting.
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Based in Sydney, Kieran Davies is Chief Macro Strategist at Coolabah Capital Investments, an asset manager with 40 executives and over $8 billion in fixed-income strategies. Kieran is responsible for macroeconomic research and investment strategy,...
Based in Sydney, Kieran Davies is Chief Macro Strategist at Coolabah Capital Investments, an asset manager with 40 executives and over $8 billion in fixed-income strategies. Kieran is responsible for macroeconomic research and investment strategy,...
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