- The Australian economy grew by 3.1% in the year to March, consistent with faster inflation and lower unemployment.
- However, the headline GDP growth rate masks weak undercurrents that continue to exist in the Australian economy.
- The ANU’s “shadow” RBA Board believe the most appropriate policy response today is for the bank to lift the cash rate.
The Australian economy grew 3.1% in the year to March, helped by a pick-up in business inventories, a rebound in commodity exports and continued strength in government demand.
On the surface, it was a strong result, leaving growth above the levels that typically lead to lower unemployment and faster inflationary pressures.
Given that’s exactly what the Reserve Bank of Australia (RBA) is forecasting, it helps explain why a majority of economists, analysts and traders believe the next move in official interest rates will be higher. Eventually.
However, while no one disputes that economic growth has accelerated, the headline GDP result masked some fairly weak undercurrents that exist within the Australian economy at present.
Underlying consumer price inflation (CPI) remains below the RBA 2-3% medium-term target and wage growth, as measured by the ABS wage price index, continues to wallow near the lowest levels on record, especially for private sector workers.
Unemployment, despite a recent decline, is still well above the level where wage pressures are expected to pick up and employment growth, fitting with an increasing number of leading indicators, has also slowed noticeably this year.
Household consumption was weak in the March quarter, fitting with ongoing softness in income growth, and many are warning this trend could continue given ongoing declines in Sydney and Melbourne property prices, creating a diminished wealth effect.
Business conditions and confidence, having sat at or near-record levels for much of the past year, are also showing signs of rolling over, in part reflective of increased trade tensions between the United States and China.
To be sure, the economy is not terrible by any stretch, but such a backdrop has some starting to question whether the RBA should even be discussing, let alone considering, an increase in the cash rate, especially at a time when wholesale funding costs are elevated.
Some believe the bank should actually cut rates given the vulnerabilities that currently exist.
It’s understandable why so many in financial markets have pushed back their expectations for the first RBA rate hike well into next year, or longer.
However, while the vast majority in financial markets believe the RBA should show caution, the ANU’s “shadow” RBA Board, made up of both bank and academic economists who critique the RBA’s policy decisions, believe interest rates should rise at the bank’s July policy meeting today.
“The RBA Shadow Board rules out any likelihood that a reduction in interest rates could be called for,” it said in a statement.
“Instead, it attaches a 49% probability that holding interest rates steady at 1.5% is the appropriate setting, while the confidence in a required rate hike equals 51%.”
In other words, based on what level individual members believe the appropriate cash rate should be, the skew of responses marginally favours a 25 basis point increase at today’s meeting.
That hawkish view was even more prominent looking six months ahead with the probability of a 25 basis point increase lifting to 73%.
While the shadow RBA Board believes that the appropriate level for the cash rate is higher, they are in the minority when it comes to broader market views.
All 23 economists polled by Bloomberg forecast that the cash rate will remain at 1.5% today. Cash rate futures reflect an identical view, indicating a 0% probability of a move in either direction at 2.30am AEST.
Perhaps most importantly of all, the RBA also appears in no rush to hike like their compatriots on the shadow board.
“If [the economy continues to move in the right direction], it is likely that the next move in interest rates will be up, not down,” RBA governor Philip Lowe said in a speech last month.
“Any increase in interest rates, however, still looks to be some time away.
“The Board will want to have reasonable confidence that inflation is picking up to be consistent with the medium-term target and that slack in the labour market is lessening.”
Until that happens, policy rates will almost certainly remain unchanged, including today.