Speaking at the Citi Australia and New Zealand Investment Conference 2024, the RBA's assistant governor for economics, Sarah Hunter, noted that the bank does not foresee a shift in inflation expectations away from its target in the near future, but it is vigilant for any potential risks that could arise
Hunter referenced internal research indicating that short-term inflation expectations "appear" to be aligning more closely with long-term expectations, which have "remained anchored" despite recent fluctuations.
“There’s no evidence of expectations being more persistent than normal,” Hunter remarked.
Well-anchored expectations, she elaborated, are vital for maintaining low and stable inflation. Using Turkey as an example, Hunter highlighted the severe consequences that can occur when expectations become unanchored.
“Given the enormous damage that such de-anchoring can cause, and that policy can be enacted more flexibly while expectations remain anchored, the RBA Board is constantly alert for signs that this risk might emerge here in Australia,” Hunter explained.
The RBA monitors various measures of inflation expectations, including indicators from financial markets and surveys of households, unions, and professional forecasters. This analysis suggests that expectations have not become unanchored amid the current high-inflation climate.
Discussing financial markets, Hunter stated they "efficiently" reflect signals about the anticipated future path of inflation within their pricing.
“It is worth mentioning that we have a reasonable understanding of how financial markets form expectations,” Hunter said.
“Financial markets efficiently incorporate signals about the likely future direction of inflation into market prices; by taking active positions that are contingent on economic outcomes, it’s no surprise that market participants keep themselves very well-informed about what’s happening.
“From these prices, we can discern whether their short- and long-term expectations remain anchored to the RBA’s inflation target.
Hunter emphasized the importance of expectations in economic decision-making, saying, “People don’t just make decisions based on what is happening today; they also factor in what they think will happen tomorrow.”
“We estimate that around three-quarters of households and unions form their expectations by extrapolating from their lived experience. That is, they observe what inflation was yesterday and compare it to what they expected. Every time inflation turns out higher than what these people expected, they partially adjust their expectations up,” she added.
“This extrapolation process happens a lot slower for households than it does for unions. That is, households only adjust their expectations a small amount each time they are surprised. As a result, inflation has to be persistently higher or lower than previously expected for expectations to change significantly.”
She illustrated this point, explaining that decisions about retirement savings are influenced by expectations of future income, which are shaped by anticipated price changes.
The RBA has reiterated its commitment to bringing headline inflation back within its target range of 2 to 3 percent, emphasizing the need for a sufficiently restrictive monetary policy to achieve this goal promptly.
Currently, the bank projects that inflation will fall within the target range by late 2026, with Governor Michele Bullock asserting earlier this month that there will be no interest rate cuts in the immediate future.
The RBA's next meeting is scheduled for November 5. As of October 15, the ASX 30 Day Interbank Cash Rate Futures for November 2024 were trading at 95.69, suggesting a 14 percent likelihood of a rate decrease to 4.10 percent next month.
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