The RBA isn't convinced it needs to cut rates - but markets still think it will

Ian Waldie/Getty Images
  • RBA Deputy Governor Guy Debelle isn’t convinced that the bank needs to cut interest rates yet.
  • In a speech on Wednesday, Debelle said the bank is waiting for confirmation as to what indicator is giving the correct signal on the strength of the economy — GDP or the labour market.
  • He said the resolution of this uncertainty will be of “crucial importance” in terms of what the the bank will do next.
  • Debelle said Australia’s Q1 CPI report could help to resolve this uncertainty.
  • Internationally, the impact of stimulus measures in China, along with trade flows, are other factors that could prove to be influential.

The Reserve Bank of Australia (RBA) isn’t convinced that it needs to cut interest rates, but it stands ready to act if and when the need arrives.

In a highly anticipated speech delivered in Adelaide on Wednesday, RBA Deputy Governor Guy Debelle stopped short of introducing an easing policy bias that would imply the bank is likely to cut Australia’s cash rate again.

Rather, he confirmed the bank is still seeking further clarification as to what indicator — GDP or unemployment — is currently providing the best signal on the strength of the economy.

“How those tensions are resolved will play a critical role in whether we continue to make satisfactory progress in achieving the goals of full employment and the inflation target,” Debelle said.

On the sharp slowdown of the Australian economy late last year, Debelle acknowledged it came as a surprise, especially the weakness in household spending which is the largest part of the economy.

“Some of the weakness was temporary, such as the disruption to resource exports and the effect of the drought. But the primary reason for this has been that consumption growth has been markedly slower than we had forecast,” he said.

“Partly this was because the rate of consumption growth was revised lower than had been earlier reported. But beyond that, the growth in consumption in the second half of the year was considerably slower than we had anticipated.”

Rather than blaming the weakness entirely on the downturn in the housing market, Debelle said sluggish household incomes growth at a time when home prices are falling may have played a larger role.

“In my view, the main explanation as to why consumption growth has slowed is the low growth in household income, and an increasing expectation that it is likely to remain low,” he said.

“I am not so sure that is from the direct ‘wealth’ effect of lower housing prices as much as it is from the fact that turnover in the housing market is at very low levels, as is typically the case when housing prices have been falling.”

Helping to bolster that view, Debelle pointed to divergent trends in household spending in New South Wales and Victoria last year, two states where home prices fell the most.

“One puzzle related to the possible wealth effect is that the slowdown in household spending has been much more pronounced in New South Wales than it has been in Victoria, despite similar declines in housing prices,” he said.

“While population growth in Victoria is higher than in New South Wales, that doesn’t account for the whole difference.”

Adding another layer of uncertainty as to what is happening in the economy, Debelle noted the conflicting signals between GDP and Australian labour market data.

“The labour market has been surprisingly strong. The unemployment rate has declined faster than we had forecast and employment growth is stronger than we had earlier forecast,” he said.

“The strength of the labour market is at odds with the slow pace of GDP growth.”

Hinting that the RBA is putting more weight on the signals from the labour market, Debelle pointed to recent trends in business investment and hiring that suggest the economy is doing far better than the GDP data would suggest.

“The labour market could be a lagging indicator,” he said.

“But at the same time, businesses continued to invest through the end of 2018 and have continued to hire into 2019. Why would they do this if growth in economic activity has slowed so much?

“Business conditions have declined from their high levels of the first half of 2018 but still remain consistent with around trend growth in the economy. This is also the sense I get from the Bank’s extensive business liaison program,” he said.

Debelle said the resolution of which indicator is right will be of “crucial importance” in terms of what the bank will do next.

“Hopefully we will get some resolution of this tension in the coming months with the incoming flow of data,” he said, nominating Australia’s Q1 consumer price inflation report and Q1 Wage Price Index that will be released over the next month.

“For inflation to rise to be sustainably within the inflation target range of 2–3%, we need to see higher wages growth,” he said.

Along with a sustained lift in Australia’s unemployment rate, the RBA has previously stated that a lack of progress in returning inflation to the midpoint of its target was another outcome that could warrant additional monetary policy support.

Internationally, Debelle also pointed to uncertainty surrounding China’s economic outlook, along with global trade, as other factors that could influence what the bank chooses to do next.

“The effectiveness and extent of the stimulus measures in China in addressing the slowdown in Chinese growth is one of the key uncertainties. Trade developments is another,” he said.

Given some analysts expected the RBA would use Debelle’s speech to signal that it’s likely to cut Australia’s cash rate again, financial markets have reacted by pushing the Australian dollar and government bond yields higher.

However, the moves have only been modest in scale with a full 25 basis point cut still priced in by the end of the September quarter this year.

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