The RBA has dialled back its inflation forecasts

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The Reserve Bank of Australia (RBA) has just released its latest quarterly Statement on Monetary Policy (SoMP), including updated projections on GDP growth, inflation and unemployment over the next few years.

Here are the new forecasts.

Source: RBA

And here are the bank’s forecasts from three months ago.

Source: RBA

Today’s forecasts are the first time the RBA has forgone the use of ranges, opting instead to make its forecasts to the nearest quarter percentage point.

This was announced last month, and was widely expected by financial markets.

So how have they changed?

The most noticeable tweak involves the bank’s underlying inflation forecasts, those which are of most importance on the outlook for interest rates, with the bank now forecasting that it will move back to the bottom of its 2-3% target range by the middle of 2019.

Not in the target band, but at the bottom of the target band.

In its previous forecasts, the midpoint had underlying inflation hitting 2% by the end of 2018 before moving back to 2.5% during 2019.

Based on these forecasts, the bank now thinks it will take longer for inflationary pressures to build.

That has implications on the outlook for interest rates, suggesting it could take longer for the RBA to begin normalising policy.

The bank’s headline inflation forecasts have also been lowered from those previously offered in August.

Outside of inflation, the board also tweaked its unemployment forecasts for the end of 2019. It now sees Australia’s unemployment rate sitting at 5.25% in two years time, below the 5.5% midpoint level offered in its previous forecasts.

Although an upgrade, the outcome suggests wage pressures over the next couple of years — a key factor on the outlook for inflationary pressures — will remain weak.

“There is uncertainty about how much wage growth will pick up in response to improved labour market conditions and the associated reduction in spare capacity,” the bank says.

“More firms have been indicating that they are finding it difficult to find suitable labour, which might lead to wage growth picking up more quickly than anticipated.

“On the other hand, the experience of low wage growth in many countries with tighter labour markets suggests that structural factors such as technological change and globalisation have had an important bearing on wage outcomes and could continue to do so for some time yet.”

Australia’s full employment rate, or NAIRU, is seen by many analysts to currently sit at or just below 5%. An unemployment rate forecast of 5.25% by the end of 2019 implies that despite a high degree of uncertainty, wage pressures are likely to remain benign.

Again, along with the downgrade to its inflation forecasts, this argues against the need for a near-term lift in interest rates.

On the outlook for economic growth, the bank’s new GDP forecasts were much the same as those offered in August.

It now sees GDP growth at 2.75% by the end of June next year, down fractionally on the 3% midpoint it offered in its previous forecasts. It also made a small reduction in its forecast for the end of 2019, trimming it by 25 basis points to 3.25%.

Outside of those tweaks, its forecasts were unchanged.

Making the downgrades to its inflation forecasts even more significant, it came despite the bank making significant changes to its Australian dollar and Brent crude forecasts.

Over the forecast period, it sees the AUD/USD and AUD trade-weighted index (TWI) at 77 cents and 65 respectively, down from 80 cents at 67 in August.

It also made a significant upgrade to its Brent forecast, seeing it average at $63 per barrel, up from $53 per barrel three months ago.

Those assumptions should help to boost inflationary pressures. However, even with those tailwinds, the bank still sees inflation lifting at an even slower pace than before.

These forecasts also use current market pricing for interest rates, another significant development.

Markets don’t have a full 25 basis point rate hike priced until early 2019. So if rates were to increase by then, and the RBA’s forecasts and assumptions are correct, it still only sees underlying inflation at 2%.

All up, it suggests the RBA is still a long way from lifting interest rates, as pointed out by Robert Rennie, Global Head of Strategy at Westpac, on Twitter.

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