RBA sees inflation returning back to the band

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The Reserve Bank of Australia (RBA) has just released updated economic forecasts for Australian economic growth and inflation as part of its quarterly statement on monetary policy (SoMP).

Here they are:

Source: RBA

And here are its previous forecasts offered three months ago:

Source: RBA

Of most interest, particularly after sitting below it for several quarters, the RBA now sees underlying annual inflation returning back to its 2-3% target by the middle of 2019, something that had been speculated upon in markets prior to today’s release.

As was the case in its November SoMP, it sees the midpoint of its underlying inflation forecasts sitting at the bottom of its target until the end of 2018, with it expected to pick up from its current level of 1.6% to 1.75% by the middle of this year.

So while it expects underlying inflation to push higher in the years ahead, it will be slow, steady lift in the RBA’s opinion.

Beyond its near-dated forecasts, it expects headline inflation to sit at similar levels to underlying inflation in the years ahead.

After the shock 0.5% GDP contraction in the September quarter last year, the bank slashed its near-term expectations for GDP growth, as expected.

It now sees GDP expanding 2% year-on-year in 2016, down from its previous forecast of 2.5 to 3.5% — a big reduction, but one that had been expected.

By the middle of this year, it sees GDP averaging between 1.5% to 2.5% before accelerating to between 2.5% to 3.5% by years end. Growth is then expected to accelerate slightly to 2.75% to 3.75% by the end of 2018.

Aside from the near-term downgrades, the outlook was largely unchanged, something RBA governor Philip Lowe flagged in his speech overnight.

On the unemployment rate, the bank expects it to remain around its current level — 5.8% — until the middle of this year. However, beyond the near-term, it has the rate averaging between 5% to 6%, a wide range that suggests there’s a large degree of uncertainty as to how labour market conditions will unfold.

The labour market was one area RBA governor Lowe singled out in his speech overnight that he’d be watching closely in the period ahead.

The RBA’s technical assumptions — inputs that help to formulate its forecasts — have the Australian dollar averaging 76 cents against the US dollar over the forecast period, down fractionally from 77 cents in November. In trade-weighted terms, it has the Aussie averaging 66, up from 65 seen previously.

That implies a slightly weaker Aussie against the US dollar, but higher against currencies of Australia’s other major trading partners.

Its Brent crude forecasts were also revised sharply higher to $US56 per barrel, up $US6 from the forecasts offered three months ago, which reflects recent strength in crude prices courtesy of output cuts announced by both OPEC and non-OPEC producers in late 2016.

It also reflects why the RBA sees headline inflation higher than underlying inflation in the near term.

There has been no market reaction to the SoMP release, suggesting that the RBA did an excellent job in preparing investors on what to expect.

The forecasts also underline why investors are starting to price in the prospect of a lift in interest rates by the RBA within the next 12 months, and why the bank itself seems comfortable with policy settings where they currently sit.

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