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RBA admits its inflation forecasts undershot reality

The RBA says its inflation forecasting was impacted by "unforecastable shocks".

The RBA says its inflation forecasting was impacted by "unforecastable shocks". Photo: AAP

The Reserve Bank of Australia has admitted its inflation forecasts significantly underestimated the reality over the past year, warning of more tough times ahead for Australians.

In its latest Statement on Monetary Policy released Friday, the RBA said it is addressing errors linked to “unforecastable shocks” and what in hindsight was an underestimation of the impact of COVID-19 related demand and supply imbalances.

“As one of the largest economic shocks in a century, the inflationary effects of the pandemic-driven imbalance between supply and demand for goods both globally and domestically played an important role in the forecast miss,” it said on Friday.

“Other unforecastable shocks – such as the effects of Russia’s invasion of Ukraine and the Australian east coast floods – also contributed,” the bank said.

“The bank’s inflation models (like most forecasting models) underestimated inflation over the past year, as it is difficult for forecasting frameworks to capture the signal from unprecedented events.”

To address this, the bank is incorporating more information from its business liaison programs, surveys and international experiences into its thinking.

RBA governor Philip Lowe this week predicted a short-term increase in inflation forecasts for the end of this year from 7.8 to 8 per cent.

And while the bank previously predicted the CPI to return to its 2-3 per cent target range by December 2024, it now expects annual price rises to remain above that level at 3.2 per cent until at least 2025.

This forecast is based on an assumption of the cash rate made using a combination of market pricing and economist forecasts, which would probably see the cash rate peaking at 3.6 per cent or more.

In its August 2021 quarterly Statement on Monetary Policy, the central bank predicted the consumer price index would range between 1.50 per cent and 2.50 per cent out to the year ended December 2022.

But the annual CPI rose by more than that, and the bank is now predicting inflation of eight per cent by the end of this year.

“None of the market economists the bank surveys nor any market-based measures predicted the extent of the pick-up in inflation,” the RBA said in its latest Statement on Monetary Policy published on Friday.

– with AAP

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