National Australia Bank’s economics team have done an abrupt about-face on the outlook for Australian interest rates, calling for two further 25 basis point cuts from the Reserve Bank of Australia (RBA) next year, taking Australia’s cash rate to just 1%.
Beyond that aggressive forecast, a stark divergence to the “on-hold” view it previously held, the bank believes that there is also the possibility of unconventional monetary policy in the period ahead.
The premise for the call is a familiar one — the low inflation outlook for Australia — a major factor behind the two rate cuts delivered by the RBA so far this year.
CPI inflation is expected to remain below the target band for an extended period, while structural shifts in the economy and modest economic growth put pressure on the labour market in the longer-term. Although we are not as quiescent as the RBA with respect to house prices, nor are we convinced lower rates will have a material impact on inflation, we do expect the RBA will react by providing further support. This will include two more 25bp cuts in May and August 2017 (to a new low of 1%), which should be enough to stabilise the unemployment rate (which is currently a concern for the RBA) at just over 5½% and prevent economic growth from dropping below our forecast of 2.6% (average) in 2018. Monetary policy deliberations may then turn to the possible use of non-conventional policy measures if the outlook deteriorates further.
On inflation, the NAB suggests that “most of the factors currently suppressing inflation are likely to persist, including low wages growth, strong retail competition both domestically and offshore, low commodity prices globally and slow growth in rents as dwelling supply picks up”.
Adding to the case for additional monetary policy support, in its opinion, the NAB believes that house price risks have become less of a constraint on the possibility of further rate cuts. It also notes that the RBA appears to be much more focused on highlighting the downside risks to the outlook, particularly in relation to uncertainty around the likely direction and the degree of spare capacity in the labour market.
It also believes that the outlook for Australian economic growth — expected to accelerate to above-trend levels based on forecasts released by the RBA in its quarterly statement on monetary policy last week — are tilted to the downside over the medium to long-term.
NAB continues to see a reasonably solid economy in the near-term, supported by an improved non-mining economy (particularly with strong growth in residential construction) and increased hard commodity production. However, the risks to the outlook going into 2018 are becoming increasingly apparent, as LNG exports flatten off at a high level and the dwelling construction cycle turns down. Consequently, NAB’s forecasts for GDP growth are factoring in more headwinds going forward, widening the spread between NAB and RBA forecasts to around 1½ ppts by late 2018 (NAB forecast 2.2% over 2018 vs RBA’s 3-4%).
The table below, supplied by the NAB, looks at its forecasts for GDP growth, underlying and headline inflation, comparing them to those offered by the RBA.
So there we have it. A major bank making a major call when it comes to the outlook for domestic interest rates.
While there are a handful of banks’ out there who have similar calls for the cash rate, the possible use of unconventional monetary policy beyond rate cuts makes this call stand out from the crowd.
Though the NAB doesn’t elaborate on what unconventional monetary policy measures may be introduced, with negative interest rates highly unlikely due to Australia running persistent current account deficits (let alone question marks over their effectiveness in stimulating economic activity), one suspects that it would involve asset purchases and loan programs, similar to measures already introduced by the Bank of England.
However, it’s all speculation at this point, not only as to what may arrive but if it will even be required.