The RBA doesn't sound like it's about to cut interest rates

Justin Sullivan/Getty ImagesCould the RBA be about to turn dovish, implying that interest rates could be reduced? Markets think it’s a risk in March.

As it has done since August 2016, the Reserve Bank of Australia (RBA) kept Australia’s cash rate unchanged at its March monetary policy meeting.

The decision was widely expected by financial markets.

However, while few expected a move from the bank today, what markets were really interested in was whether it would signal that it’s moving towards cutting interest rates.

While the commentary in the March policy statement was littered with dovish commentary, including an acknowledgement the Australian economy “slowed” in the second half of last year, RBA Governor Philip Lowe provided few hints that the board is considering a near-term reduction in the cash rate.

“The low level of interest rates is continuing to support the Australian economy,” he said, repeating the line that’s been a feature in statements for the best part of a year.

“Taking account of the available information, the Board judged that holding the stance of monetary policy unchanged at this meeting would be consistent with sustainable growth in the economy and achieving the inflation target over time.”

That too was unchanged from the February statement, underpinned by a view that inflation is still expected to lift gradually back towards the RBA’s 2-3% inflation target.

“Further progress in reducing unemployment and having inflation return to target is expected, although this progress is likely to be gradual,” Lowe said.

Ahead of Australia’s Q4 GDP report released on Wednesday, Lowe acknowledged that the economy slowed late last year. However, crucially, he said the RBA still thinks the economy will grow by 3% this year, keeping it above the trend level of around 2.75% that should help to lower unemployment and lift inflation gradually.

“The central scenario is still for the Australian economy to grow by around 3% this year,” he said.

“The growth outlook is being supported by rising business investment, higher levels of spending on public infrastructure and increased employment.”

The acknowledgement that employment growth was helping to support the economy was an addition to the March statement, even though year-ended growth in hiring has slowed substantially over the past year or so.

“The Australian labour market remains strong,” Lowe said, adding that employment growth had been “significant”.

“A further decline in the unemployment rate to 4.75% is expected over the next couple of years. The vacancy rate is high and there are reports of skills shortages in some areas.”

Lowe also expressed confidence that stronger job market conditions will continue to lift wage pressures, describing a recent pickup as “welcome” given it should help to improve household income growth.

“The stronger labour market has led to some pick-up in wages growth, which is a welcome development,” Lowe said.

“The improvement in the labour market should see some further lift in wages growth over time, although this is still expected to be a gradual process.”

However, while the RBA continues to bank on strong labour market conditions to support the economy, potentially offsetting that, or even perhaps reversing recent progress on lowering unemployment and lifting wages, Lowe continued to express uncertainty over household spending, the largest part of the economy.

“The main domestic uncertainty continues to be the strength of household consumption in the context of weak growth in household income and falling housing prices in some cities,” he said.

“A pick-up in growth in household income is nonetheless expected to support household spending over the next year.”

Given recent trends in Australian economic data, including the wages and salaries measure in the Q4 business indicators that suggests total growth in wages per person was soft in the final three months of last year, it’s likely that not everyone will share the RBA’s rosy outlook.

On the housing market, at the epicentre of domestic economic uncertainty, the RBA made few significant changes in the March statement. And of those changes, they only conveyed the message seen in recent data.

“The adjustment in the Sydney and Melbourne housing markets is continuing, after the earlier large run-up in prices. Conditions remain soft in both markets and rent inflation remains low,” Lowe said.

Lowe noted that credit conditions for some borrowers have “tightened a little further over the past year or so”, including to owner-occupiers which had “eased further”.

He also noted that “short-term bank funding costs have moderated”, lessening the potential risk for further out-of-cycle variable mortgage rate increases in the near-term.

Certainly no signs of panic in that commentary, but it’s clear the RBA is watching trends in credit growth closely given the link to home prices.

Outside of those key areas of debate, the RBA’s language on the inflation outlook was left unchanged, partially as a result of no new official data being released since the board last met. It’s views on the Australian dollar and Australia’s terms of trade were also unchanged.

Internationally, Lowe repeated the view that “downside risks have increased”, including that “trade tensions remain a source of uncertainty”.

Despite those risks, he said “the outlook for the global economy remains reasonable”.

Reflecting recent movements in stocks, corporate credit spreads and bond rates, the RBA acknowledged that financial conditions remained “accommodative” and had “eased recently after tightening around the turn of year”.

“Long-term bond yields have declined, consistent with the subdued outlook for inflation and lower expectations for future policy rates in a number of advanced economies. Also, equity markets have risen, supported by growth in corporate earnings,” Lowe said.

That suggests the economic risks stemming from financial markets have decreased in the RBA’s opinion, removing one threat to the domestic outlook for now.

While the RBA left the key final paragraph of the statement unchanged in March, scuppering limited speculation that it may signal a potential rate cut as has been the case in previous easing cycles, it’s clear the the RBA is not as bullish on the domestic economy as it was just a few months ago.

Yes, job market conditions are strong, but that’s perceived to be a lagging economic indicator, telling us more about how the economy was performing in the middle of last year rather than where it is heading.

While it remains strong, many other parts of the economy remain sluggish, meaning any sign that labour market conditions are starting to soften may quickly see the RBA move to ease policy again.

There’s some signs from recent job ads and PMI data that suggest employment growth is already or likely to weaken further, but that has yet to trigger a lift in unemployment, nor a subsequent reaction function from the RBA.

Looking ahead, market attention will now turn to a key speech from RBA Governor Philip Lowe on Wednesday entitled “The Housing Market and the Economy”.

Given the topic, and uncertainty about the outlook for household spending, it’s likely to attract a lot of attention, especially as Lowe dropped something of a bombshell in a speech delivered immediately after the RBA’s February board meeting, moving the bank from a mild tightening to neutral bias on the outlook for the cash rate.

A similar outcome could be seen tomorrow.

Beyond that speech, Australia’s Q4 GDP report will also be released on Wednesday. Another weak result is widely expected, leading some to speculate that it could see the RBA reduce the cash rate in the months ahead, depending on severity of the slowdown.

While the RBA still sees a steady cash rate as “consistent with sustainable growth in the economy and achieving the inflation target over time,” that view may not remain in place for long.

The RBA’s March policy statement can be accessed here.

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