ANZ says the RBA will leave interest rates unchanged 'deep into 2018'

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Even though they appear to have stabilised, underlying inflationary pressures in Australia are likely to remain weak for some time yet, and that means that the prospect of rate hikes from the RBA are unlikely to be seen well into 2018.

That’s the view presented by David Plank and Giulia Lavinia Specchia, economists at ANZ, who point to the bank’s Inflation Risk Index (IRI) to show that the outlook for underlying inflation, for the moment at least, remains skewed to the downside.

Here’s the IRI in chart form, a bright colour-coded way to communicate the risks to the inflation outlook over the next 12 months base off modeling conducted by ANZ.

Source: ANZ

It’s constructed using three main factors to determine where inflation is likely to move in the future: ANZ’s Labour Market Condition Index, it’s Wage Gauge, something which it says is a good proxy for labour cost growth in Australia, along with its G7 Core Inflation which it uses to proxy international inflationary pressures on Australian prices.

Light blue indicates the probability that underlying inflation — that targeted by the RBA — is likely to remain below the bank’s 2-3% target, while dark blue points indicates the likelihood that core inflation will move above the bank’s target band over the next 12 months.

Sandwiched in the middle, and shown in orange, is the probability that inflation will move back into the bank’s 2-3% band within 12 months, something that the RBA sees occurring by the middle of 2019 based off forecasts offered in its May Statement on Monetary Policy.

Currently, the IRI points to a 60% probability that underlying inflation will move back to within the RBA’s target band over the next year. A 40% chance is assigned to inflation remaining below the bank’s target, while an above-target outcome is seen as close to zero.

While an encouraging outcome, indicating that underlying inflationary pressures have stabilised and perhaps even starting to edge higher, Plank and Specchia believe that the risks to the inflation outlook remain to the downside, providing the conditions to allow the RBA to keep the cash rate unchanged for an extended period.

“The weakness in core inflation suggests that rate rises are off the table for some time yet,” they wrote. “This is consistent with our view that the RBA will keep rates on hold deep into 2018.”

Australian interest rate futures agree with this assessment, not seriously pricing the prospect of a rate hike until the second half of next year.

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