Jason Daw:
Hello and welcome to Macro Minutes. During each episode, we'll be joined by RBC Capital Markets experts to provide high conviction insights on the latest developments in financial markets and the global economy. Please listen to the end of this recording for important disclosures.
Cathal Kennedy:
Hello there everybody, and welcome to this special edition of RBC's Macro Minutes focused on the UK and Australia. It's the 20th of May 2025, and it's just before nine AM UK time, 6:00 PM Australian time. And this morning joining us, hot off the RBA's policy decision, is our Australian economist, Su-Lin.
Su-Lin, straight to the business end of things as we will. We just had the RBA announcement overnight here in the UK, 25 basis point cut as expected, but what an interesting surprise in the tail of the meeting.
Su-Lin Ong:
It was indeed, Cathal. Hi everyone. And we have just had a really interesting decision from the Reserve Bank. So a 25 basis point cut to 385 was universally expected and fully priced, but the surprise really was in what was a very dovish cut in our view, and that reflected I think three key components of the communication today. So we got a company board statement, we had the quarterly statement on monetary policy, and we had the governor's press conference and all three pieces of communication, erred heard quite dovish.
So firstly, we saw some pretty interesting revisions to their key macro forecasts in their quarterly statement. We had a downward revision to GDP this year by just over a quarter of a percent. A lot of that was concentrated in weaker household consumption. We had a small upward revision to the unemployment rate, that now lifts to 4.3 over the forecast horizon.
Most importantly, we had a downward revision to their core inflation forecast. So they were 2.7 all the way through to mid 27, and that's now down at 2.6%. So, it's interesting because the banks talked a lot about aiming for sustained within target inflation, between two to 3%, and really mid-point inflation, and arguably we're really not far from there in terms of their forecast.
So the revisions to the forecast gave it a very dovish tilt, but more importantly, I think it was really the language in both the detailed quarterly statement as well as her press conference. She really talked about the risk to inflation being more balanced, the upside risk dissipating, and talked a lot about the downside risk to global growth and the uncertainty. So that language was quite dovish throughout the statement as well as a press conference.
And then I think thirdly, the press conference actually suggested that they did discuss a fifty-point cut today, which really to us was quite surprising given lots of uncertainty, the fact that inflation is only just back within target. That was a pretty bold discussion we thought, but look, not surprisingly, markets latched onto that. Bonds that were already bid took another leg higher, pricing for easing has stepped up. And so that added, I think, to what was overall a very dovish cut and a central bank that feels pretty confident that inflation is back within target and that the downside risk to global growth give it, I think, that extra confidence.
Cathal Kennedy:
Fascinating, Su-Lin, and in stark contrast, I think, the recent Bank of England's decision. I think you mentioned there about the RBA being confident that inflation was back within target. Can you just explain how that was reflected in today's decision?
Su-Lin Ong:
Yeah, look, I think what's interesting is the most recent quarterly inflation data put the key measure of underlying inflation trimmed mean at 2.9%, so back within target for the first time since late '21. Importantly when we dug into the details, we also saw an easing in services inflation, non-tradable inflation. So some of the more stickier components that we know they're watching pretty closely. I think that that's given them some comfort that inflation finally is back on track.
They've also talked a bit about whether it's possible that full employment and NAIRU is lower and they're still open I think to that discussion. So the labor market is pretty healthy unemployment rate at 4.1% wages growth has picked up a little but still remains reasonably well-behaved. And so I think when you look at that and you combine it with the downside risk to activity, they seem to be a bit more confident on inflation.
Now, time will tell, we worry that productivity is low, that there is still a lot of global uncertainty, but the RBA does seem increasingly confident on that front. And it's interesting because the governor today reminded us that the RBA's run a bit of a different game in terms of monetary policy. It didn't take rates obviously as high. It didn't cut last year accordingly. It's been trying to preserve the gains of the labor market and tolerate higher inflation.
I mean, that strategy seems to have paid off. Inflation is now back within target. The labor market remains healthy. There are these great uncertainties globally and some downside risk, but they I think that that will help keep inflation I think within that target range. So, they definitely are sounding a bit more confident. Time will tell.
I mean, I would say that the quarterly statement, which is about 70 odd pages long, does have the word uncertain or uncertainty mentioned 132 times. So this is a bit of a common theme I think with central banks globally given everything that's happening. So it would be wise to maybe be a little bit more cautious on the growth and inflation outlook, but they definitely, I think, feel a bit vindicated in their strategy given where we sit at the moment.
I think, Cathal, you do point out that obvious contrast with your recent cut from the Bank of England that was definitely more hawkish. I think more hawkish than both you and the market expected. The RBA talked a lot today about global trade concerns and the uncertainty, and we are obviously a medium-sized very open economy. And so what happens globally, particularly in terms of global growth and commodity prices, impacts quite substantially here. But the Bank of England didn't seem as moved by global trade concerns. Is that a fair comment and why do you think that's the case?
Cathal Kennedy:
Yeah, I mean, it is a very fair comment. I think the takeaway from the May meeting, we too had a forecast around on a fresh monetary policy report alongside, and the takeaway really was not how little, but perhaps, how much more weight, as you put it, the Bank of England is still placing on domestic factors in its deliberations. I mean, if you look at the bank's forecasts, I mean, the impact of the trade uncertainty as they described it too, it was actually fairly minimal. I mean, only shaved .3, .4 near term GDP, and I think the inflation forecast was only revised down by .3, .4 a quarter as well.
So you had to look very hard to see where all this uncertainty that the MPC were referring to was actually showed up in the forecasts. And I think what was interesting, what made the takeaway for us I think that surprised everybody was not only did the MPC retain their gradual guidance, which they put in place last November, remember, in the wake of budget here in the UK, not only did they retain that, but they didn't really make any adjustment to it whatsoever. I mean, we thought it'd retain some degree of caution in the language going forward, but to retain it wholesale and make no changes was a big, big surprise to us.
And indeed, we had an event last week, which is really interesting, the bank's watchers conference something the ECB does as well. And at that there was a question in essence, why didn't you adjust the gradual guidance and what they basically... That was Clare Lombardelli, who was the deputy governor for monetary policy, and what she basically said was that they retained it because essentially the domestic factors they were looking at, wages and services, were still too high for comfort and that trade didn't really play that bigger role in this sort of decision at the main meeting.
Su-Lin Ong:
So it is an interesting contrast because I would say domestic considerations were important. The fact that inflation is within target is important to them. Some downside to economic growth domestically, partly from a consumer that is probably not recovering as fast as they expected also lent a bit of a dovish tilt to today's decision. But I think it's pretty clear the global factors for Australia are probably more important than for the Bank of England.
And that comes through quite clearly in today's communication from the RBA. It is interesting, the bank today did some scenario analysis and I know other central banks have done this, which is prudent I think in a world where there's a lot of uncertainty. But it did get a bit of a highlight in some of the commentary, the downside scenario, possibly severe downside, and that stems very much from the global factors, trade uncertainty, the risk of retaliation, the to supply chains, all of that downside scenario would mean clearly the bank would have to move a lot more quickly. And that came through quite clearly in today's communication as well.
And so I think for Australia, in contrast maybe to the Bank of England, the global factors are more important and that does reflect how integrated we are, particularly into China in this region, but more broadly through the global commodity price, transmission and global growth. So there is a bit of a difference there.
I guess what I would ask you as well, Cathal, is what would change really that gradual approach that the Bank of England is flagging towards further easing that sort of quarterly pace? What could shift that in your view?
Cathal Kennedy:
So I mean you mentioned the quarterly pace and we after the meeting, going into the meeting, we talk quarterly, well, quarterly meant to 25 basis points, and the quarterly forecast meetings this year, we still retain a few. So we have two cuts in our forecast for the August and November meetings. The market I think is pricing slightly less than two full-break cuts for the Bank of England now.
Interestingly, you mentioned scenarios. The MPC too had two scenarios. One was essentially domestically focused, which I think said that a greater or long-lasting weakness in demand reflecting global conditions might bring inflation down faster. Or another one which basically said greater persistence in domestic wage and price setting might cause inflation to be higher for longer. Now, what the bank didn't do was they didn't discuss the relative weight placed on those two scenarios. So we don't really know.
They gave an upside the downside scenario, but didn't really say which weight. I mean, my observation from the last three events the bank has done, February-May meetings and the watchers conference, is probably placing more weight, like I said, on those domestic factors, the wages here in the UK, private sector wage growth is still around 6%, considerably higher than the bank thinks is consistent with the inflation target. I think to your question, what might make them adjust? What might them make them go quicker? I think you would have to see a material loosening in the labor market and wage growth slowing on the back of that, slower more than expected.
The MPC expects wage growth to be 4% by the end of this year. I think to deliver those two cuts we're expecting they have to be comfortable, if you will, that wage growth is on a trajectory consistent with getting to that 4% by the end of the year. I think if you look at one thing, which I think plays in the mind a little bit, is that the second half of last year we had, I mean, essentially UK growth slow with standstill and loosening in the labor market, yet wage growth accelerated.
So I think for them there's a supply mismatch, a supply dynamic at work, which explains why services inflation in particular still coming down very slowly in the UK. So if the Bank of England is to shift from that gradual guidance and the way we view every data point now does this cause them to shift from gradual? I think you'd have to get a big slowdown. Essentially, the labor market would have show signs of cracking and that would slow the wage growth, which I think is the central focus still of the MPC here.
Su-Lin Ong:
Yeah, that's interesting. I mean, we too, Cathal, think that the RBA will cut again similar timing to the Bank of England, August and November, but I guess maybe in contrast to you, there must be some risk given how dovish the RBA was today that they go a little quicker and try and get to neutral sooner. At 385, we would argue that policy settings are still mildly restrictive. Their forecast and language today suggests they'll want to get to neutral, which we would put probably around three and a half percent, three and a quarter percent, so that is consistent with two more cuts.
The market here has not surprisingly lifted the odds of them maybe following up in July with a cut and lowering terminal back down to 3%. So, there's been some reasonable moves in our market post today's statement. But I think a bit like yourself, we're going to have to look at all the data as we go forward.
Domestically, the labor market numbers here are important as well. Still pretty tight, and in the RBA's own words, still erring slightly tight. Not convinced that NAIRU is lower yet, and so that too I think will be a bit of a focus here. But look at the end of the day, I suspect that once we get past the next day or two, attention will very quickly shift back to global developments. That's clearly been the key driver of markets in Australia and elsewhere. Domestic data and developments have largely taken a back seat and that global focus does come through very much from the Reserve bank today.
Cathal Kennedy:
Thanks, Su-Lin. Look, I think that was a fascinating discussion, and I'm really comparing and contrasting the two very divergent messages that the RBA and the Bank of England are giving at the moment. With that, I think we will leave it there and wish all those listening, hope that you found this informative today and look forward to speaking to you again in the future.
Jason Daw:
Thank you everyone for joining this episode. If you have further questions, you can reach out to us directly or via your sales coverage or visit RBC Insight to read our content.
Speaker 4:
This content is based on information available at the time it was recorded and is for informational purposes only. It is not an offer to buy or sell or a solicitation and no recommendations are implied. It is outside the scope of this communication to consider whether it is suitable for you and your financial objectives.