The Reserve Bank of Australia (RBA) released updated economic forecasts for inflation, unemployment and GDP growth earlier today.
And, as is often the case, they’ve created more than a few talking points.
The bank slashed its forecasts for underlying inflation over the next two years, suggesting it will not move back to the bottom of its 2-3% target range until 2019.
Previously, it had underlying inflation at 2.5% in 2019, so today’s forecasts represent a pretty significant downgrade of 50 basis points.
It might not sound like much, but for an inflation-targeting central bank, this was pretty significant.
Essentially, the RBA thinks inflation — a key determinant on the outlook for interest rates — won’t be back within target for at least another two years.
That implies that there’s absolutely no need to lift interest rates anytime soon.
While the markets were largely unmoved by the news, perhaps reflecting that downgrades were expected given recently announced updates to the the ABS’ consumer price inflation (CPI) basket and a soft CPI report in the September quarter, it’s time to see what Australia’s economic community has made of the RBA’s changes.
Bill Evans, Westpac
The big change comes with the policy sensitive inflation outlook. Underlying inflation is now forecast at 1.75% for 2017, 1.75% for 2018, and 2% for 2019. These changes should not be entirely attributed to the revised weights in the CPI as released by the Australian Bureau of Statistics on November 6th.
These changes are much more significant than that from a policy perspective.
The Bank is now telling us that over the whole course of 2018, inflation will remain below the bottom of its 2-3% target zone, and in 2019, it will only reach 2%, the bottom of the target range. This is a significant departure from the forecasts in August.
It is our view that the decision to lower the forecasts to below the bottom of the band in 2018 and at the bottom of the band in 2019 has significant policy implications. We are now assessing a central bank which is expecting that it will undershoot its core inflation target for another year, and that even one year out, inflation will still be at the bottom of the target zone.
It is uncomfortable for a central bank to be consistently undershooting its target, and it would be surprising if it felt the need to tighten policy at a time when inflation is below its target. That is especially true when the expectation for the next year, when policy can be anticipated to have its effect, is that inflation will only be at the bottom of the target zone.
We are not changing our view that rates will remain on hold in 2018 and 2019, but we have always been uncomfortable that the central bank’s forecasts were implying that it was expecting that it would be raising rates in 2018. These forecasts no longer portray a central bank that expects to raise rates.
Su-Lin Ong, RBC Capital Markets
We were not surprised by the near-term downward revision to the RBA’s inflation forecasts but more so by the medium-term forecasts. Like the global trend, they hint at a structural element, with the muted wages story playing a key part. For the first time in years, the RBA’s inflation forecasts are slightly lower than our own and suggest scope to cut the cash rate if activity/labour market disappoint.
At a minimum, the RBA’s latest set of forecasts suggest an extended period of steady cash well into 2018. We would argue that, similar to a number of other central banks, the RBA may not need to see core inflation back within target to begin policy normalisation, but it will need to be confident that key leading indicators—wages/average earnings—are strengthening. At this juncture, this would seem some way off. We stick with our base case for the cash rate to remain steady at 1.5% through to the end of 2018.
Paul Dales, Capital Economics
The Reserve Bank of Australia admitted in today’s Statement on Monetary Policy (SoMP) that underlying inflation will be below its 2-3% target for a year longer than it previously thought. We have been saying as much for over a year and we think the RBA may end up missing its inflation target for five years in a row.
The RBA’s lower inflation forecasts may prompt some calls for the Bank to cut interest rates below 1.5%. That seems extremely unlikely without a major deterioration in the economic outlook and a rebound in the unemployment rate from 5.5% to well above 6.0%. Admittedly, financial stability risks received less airtime in the SoMP than recently, but the RBA won’t want to inflate house prices again. Equally, though, with the housing market looking very fragile and household debt high and rising, now is not the time to turn a blind eye to low inflation and raise interest rates.
Market interest rate expectations have already fallen a long way towards our view that the RBA won’t hike rates until late in 2019. We suspect that trend will continue, which may contribute to a weakening in the Australian dollar to around US$0.70 next year.
Joanne Masters, ANZ
The RBA’s forecasts for inflation in 2019 were a little lower than we had expected, but the Bank very clearly states, “the assessment of pricing pressures in the near term has not changed,” but that “the forecasts have been lowered a little to account for [the ABS’ CPI basket weighting] methodological change”.
The Bank estimates that the substitution bias reached 0.4 percentage points (ppt) for year-ended headline CPI inflation in the September quarter. This is larger than our estimate of a 0.2ppt difference. The RBA also noted that underlying inflation would have been about 0.3ppt lower over the year. From a policy perspective, the Bank will look through the technical changes.
With growth expected to be above 3%, the unemployment rate is forecast to gradually decline and inflation broadly stabilise around the bottom of the target band, we continue to think that maintaining a negative real cash rate through 2018 will be overly stimulatory. Assuming the economy evolves as expected, we continue to expect the RBA to hike rates in 2018
Diana Mousina, AMP Capital
The overall tone in the Statement was upbeat but the central bank did downgrade its domestic GDP and inflation forecasts over the next two years. The outlook for the global economy is still very positive, and prospects for Australia’s major trading partners are stronger compared to the last central bank Statement three months ago.
The low inflation outlook painted by the RBA indicates that rate hikes will still be some time away. We remain of the view that an improving domestic growth landscape (helped by offshore) will allow the RBA to raise interest rates late next year, but the expectation that inflation will remain even lower for longer means that the risk is that rate hikes won’t start until 2019.
Ivan Colhoun, National Australia Bank
The RBA remains a bit more upbeat on the global growth outlook and continues to expect the Australian economy to grow around 3% over the next few years.
This is expected to see further progress on reducing spare capacity in the economy, which is seen as important in boosting wages and inflation. The forecast for unemployment has been reduced to 5.25% from 5.5%, with only a slow decline expected. Overseas experience in countries that have lower unemployment rates than Australia mean the Bank has significant uncertainty about how wages will respond to lower unemployment and in turn how higher wages will flow through to inflation; and
There is no suggestion of any near-term move in Australian interest rates in either direction. Further progress on lowering unemployment is likely a necessary condition before any move to reduce accommodation, though it’s likely that some greater certainty about a pick-up in wages will also be required.
George Tharenou, UBS
Overall, the RBA today continued their ‘downgrade cycle’ of many years, cutting their forecast profile for both GDP and headline CPI by 0.5 percentage points. But even we were surprised at how dovish the RBA’s underlying CPI forecasts were, given they now never reach above 2%. While the [ABS] reweighting impact will drag CPI in 2018, due to the implementation of annual reweighting going forward, the impact fades to almost nothing in 2019. Hence, the RBA also slashing their 2019 underlying CPI forecast by 0.5 percentage points is a dovish signal. We continue to expect the RBA to stay on hold until the fourth quarter of 2018. You can also forget about near-term rate hikes.
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