As expected, the Reserve Bank of Australia left official interest rates unchanged today at 1.5%, where they have remained since the bank cut rates by 25 basis point in August 2016.
Despite that, the central bank made some notable changes to its forecasts for inflation and unemployment.
It now expects headline inflation to fall to just 1.75% in the September quarter, having previously forecast CPI growth of 2-2.5% in the second half of the year.
At the same time, the RBA struck a more optimistic tone in its forecasts for the unemployment rate, which is now expected to dip to around 5% over the next couple of years.
The adjustments were flagged ahead of this Friday’s release of the RBA’s quarterly Statement on Monetary Policy, which will include an updated set of projections for economic growth, inflation and unemployment.
In view of that, there’s a bit to unpack in the wake of the latest rates announcement.
Let’s find out what the experts have to say:
Bill Evans, Westpac
The August statement has the benefit of an update on inflation developments. The June quarter inflation report was slightly below market expectations but not sufficient to alter the bank’s views. Having said that, a literal interpretation of the sentence “the central forecast is for inflation to be higher in 2019 and 2020 than it is currently” would be that the forecasts for inflation in the August Statement on Monetary Policy are set to be lifted.
One clue to this puzzle is that the Governor points out that headline inflation to the September quarter is likely to fall to 1.75%. As such, the forecast for headline in the May SOMP of 2.25% in 2018 and 2019 indicates a lift from the expected September reading. Such fluctuations in the headline number are unlikely to have any implications for policy.
Westpac has long held the view that the RBA cash rate will remain on hold over the course of 2018 and 2019.
In his statement, the Governor does not provide a convincing commentary that wage pressures can be expected to lift; the housing slowdown and the associated wealth effect will not be headwinds for the economy; any evidence that inflation pressures are likely to build; and why global developments are not pointing to some challenges for Australia. Consequently we see no reason to be persuaded to change our view that rates will remain on hold.
Ben Jarman, JP Morgan
The commentary was fairly similar to July’s statement, though the slight tweaks generally erred on the sunnier side. The bank seems a little more confident in the labour market’s momentum now, and are particularly sanguine on any tightening of financial conditions being imparted by mortgage restrictions.
On inflation, today’s statement notes that headline inflation will be higher in 2019/20 than currently, though with near-term downgrades seemingly coming in the SoMP. While recently-announced cuts to utility prices will no doubt be a drag in 3Q, this revision seems large, particularly if it relates to %oya 4Q18 forecast which is currently 2.25%. Nevertheless the RBA’s reaction function has become much more growth-sensitive than inflation-sensitive over the last couple of years, so even quite meaningful inflation downgrades don’t carry as much significance any more.
Having played a principal role in the credit tightening underway, it is no surprise that RBA officials have described the adjustment as a positive that has reduced systemic risks, while downplaying any fallout. So it was again today. The fall in housing credit growth is “largely due to reduced demand by investors as the dynamics of the housing market have changed”.
We do not anticipate any changes to the RBA’s growth forecasts in Friday’s SoMP. We continue to think the risk is on the downside on the RBA’s growth forecasts and policy will remain on hold for a considerable period of time.
Sul-Lin Ong, RBC Capital Markets
The RBA dropped its reference to “the Chinese economy continues to grow solidly” and replaced it with “growth in China has slowed a little”. This is not particularly surprising and largely acknowledges the recent softer data run and accompanying policy action.
Secondly, the new addition highlighting the drought adds another source of downside risk to AU growth. Thirdly, while the discussion was limited, the statement noted the further easing in conditions in Sydney and Melbourne housing and added lower “nationwide measures of rent.” These small shifts, coupled with the other key developments since the board last met – escalating US/CH trade tension and still elevated funding costs – are being watched closely by the RBA.
As global developments become increasingly important to the policy debate, with growth in Australia’s major trading partner moderating and accompanying Chinese policy action moving in the opposite direction to G7 policy normalisation, the RBA debate becomes more complex. The longer the RBA stays on hold, the greater the uncertainty as to the direction of the next move, should the global picture weaken further in 2019 and more so in 2020.
Paul Dales, Capital Economics
The RBA quite rightly sounded a little less upbeat on the global outlook. In contrast, its comments on the domestic economy sounded a bit more optimistic. The RBA suggested that the recent data supported its forecasts that “GDP growth is expected to average a bit above 3% in 2018 and 2019” and that inflation will “be higher in 2019 and 2020 than it is currently”, although it will fall back below later this year due to falls in some “administered prices” (presumably gas and electricity).
And the RBA has revised down its forecast for the unemployment rate in a couple of years’ time, and may have become less worried about housing. We accept that GDP growth in the first half of this year has been a bit stronger than we expected and that consumption has proven more resilient to low wage growth and falling house prices. Even so, house prices in Sydney and Melbourne are falling at annualised rates of 5-10%. And that’s before the full impact of the recent tightening in credit conditions has been felt and we expect conditions to tighten further.
This housing downturn may prove to be the longest and deepest in Australia’s modern history. In our view, the risk is that the average rate of GDP growth will be closer to 2.5% than 3% over the next few years, and that underlying inflation will stay below 2% for another two or three years.
Shane Oliver, AMP Capital
The RBA’s Statement accompanying the decision provided no surprises. It made no major changes to its underlying growth outlook where its sees growth picking up a bit above 3%. However, it continues to see the consumer spending outlook as uncertain, the statement now includes a reference to the drought, it notes that China has slowed a little and that uncertainty remains around US trade policy.
While the RBA does not appear to be too fussed about falling home prices it would have to be feeling a little bit nervous about it given the build up in household debt in recent years and it would be aware that when house prices and auction clearances have been this week in the past it has actually started cutting interest rates.
Once again, there is nothing in the RBA’s latest Statement to suggest an imminent change in monetary policy. The next move is probably still up but not until second half 2020 at the earliest and there is a rising risk that the next move will actually be down.
Kristina Clifton, Commonwealth Bank
Despite the stronger jobs outlook the RBA are still expecting wages growth to pick up only gradually. We note there are some positive signs on wages growth. CBA’s PMI surveys are reporting some lift in wages. And the RBA’s liaison program is showing that a growing proportion of businesses are expecting wages growth to pick up. Stronger wage expectations from businesses tends to lead a pickup in wages growth.
On inflation, the RBA maintain their forecast that inflation will gradually rise over the next few years. However, the 2018 headline inflation forecast has been revised noticeably lower. We think that they are referring to a smaller than usual seasonal increase in electricity and gas prices. The statement did not mention the underlying inflation forecasts. It’s likely that these are broadly unchanged.
The statement makes brief reference to the latest drought. This is a new risk to watch in terms of the domestic economic outlook. We think that the impact of the drought is likely to show up in 2018/19 financial year data. It probably won’t be visible in the high frequency data but previous droughts have knocked 0.4-0.8% of GDP growth.
The generally positive commentary around the global outlook remained this month. Although the RBA note that “growth in China has slowed a little, with the authorities easing policy. The reference to strains in emerging market economies has been removed from the statement this month. So that’s one less thing keeping the RBA up at night!
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