NAB: The RBA's unsure why the economy is doing better, but it looks like the rate-cutting cycle is now complete

Mitchell Johnson celebrate another wicket in the Ashes. Photo: Getty

The RBA is feeling much happier about the state of Australia’s labour market, judging by the minutes of the board’s July meeting.

The board’s improved outlook is the key difference in the minutes, which largely reflect the RBA’s monetary policy statement.

It certainly caught the attention of NAB chief economist Ivan Colhoun who, in a research note following the release, believes the minutes diminish the likelihood of further rate cuts, and will likely see the bank reduce unemployment forecasts in its upcoming quarterly statement of monetary policy.

Here’s Colhoun on the conundrum the improvement in recent labour market data has created for the RBA board.

“The broad forces impacting the Australian economic outlook remain weakening mining investment, strong housing construction (now being boosted by alterations and additions), strong resource exports (impacted by positive weather effects in Q1, but negative weather effects in Q2), moderate consumer spending and weak public demand.

These well known forces have resulted in the RBA’s below-trend forecast for GDP growth and a rising unemployment rate forecast. However, the most recent unemployment data is not playing ball with the Bank’s forecast, with employment strengthening and the unemployment rate beginning to fall. And job advertising strengthened further in June.

That’s something of a conundrum for the RBA, as it either suggests growth is not growing below trend, as expected, or trend growth is lower than expected, either of which would not suggest a pressing need for further reduction in interest rates, given the effects of the two most recent rate cuts are still to fully flow through the economy. For now, the Bank opts with slower population growth as providing the reconciliation, and supports the current policy setting by adding that even with the better than expected labour market outcomes of recent times, spare capacity in the labour market remains evident in weak wages growth and the relatively high unemployment rate, which is a reasonable argument”.

What Colhoun is suggesting is that Australia’s economy is now no longer growing below trend, or what the RBA once thought to be trend growth is actually lower than they initially forecast. Either way, with conditions in the labour market appearing to have improved, and unemployment falling, it diminishes the need for further rate cuts to stimulate the economy.

Colhoun points out the July minutes “seem to be searching for reasons why the economy may be doing a little better than expected”. That is, while they don’t know why the economy appears to be improving, they’re admitting, albeit cautiously, that it is.

As the chart below shows, Colhoun believes that “it’s very likely that RBA will need to revise lower its forecast for unemployment in the August Statement of Monetary Policy” in light of the improvement seen in the domestic labour market.

Colhoun believes that RBA are now likely to leave the cash rate on hold for “an extended period” before they begin to tighten policy from late 2016.

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