It may be a new year, but the outlook for Australian interest rates appears much the same.
The RBA issued its first interest rate decision of 2018 yesterday and thinks the global economy is in rude health. And, with the exception of the household sector, it shares a similar view on what’s happening in Australia.
Despite the optimism, the bank still appears a long way from raising interest rates, admitting that while stronger labour market conditions in Australia are helping to lift inflationary and wage pressures, the “progress is likely to be gradual”.
“Taking account of the available information, the Board judged that holding the stance of monetary policy unchanged at this meeting would be consistent with sustainable growth in the economy and achieving the inflation target over time,” it said.
Not exactly the tone one would expect from a bank about to make an imminent change in interest rates.
Financial markets certainly thought so with the Australian dollar and Australian government bond futures barely budging following the interest rate decision.
As was the case before yesterday’s meeting, markets expect the next move in interest rates to be higher, just later this year or in early 2019.
Now that markets have had their say, let’s see what economists have made of the RBA’s policy statement.
Are rates going nowhere fast, or was there something in the statement that suggests they could change sometime sooner?
Let’s find out.
Sally Auld, JP Morgan
There were some changes to the Statement — in the final paragraph, the forward guidance was unchanged, but it was noted that “further progress in reducing unemployment and having inflation return to target is expected, although this progress is likely to be gradual”. This is a signal that the next move in rates will be up, but not anytime soon.
Importantly, the RBA notes that data since the Board last met are consistent with the view that GDP growth should average a bit above 3% in coming years. This signals few, if any, forecast changes in Friday’s SoMP.
Today’s retail sales data would be a salient reminder that while Q4 household consumption is likely to look better than that recorded in Q3, it is unlikely to do the heavy lifting for GDP this year. While other parts of the economy have firmed, particularly business investment, our view is that the net outcome will still be sub-trend growth, inflation below target and an unemployment rate above NAIRU.
This is clearly a different narrative for the economy relative to that presented by the RBA in today’s Statement, but it underscores our view that the RBA will remain firmly on hold in 2018.
Paul Dales, Capital Economics
The jitters in the financial markets are due to concerns that global interest rates will rise rapidly, but the RBA did its part to calm fears by leaving interest rates at the record low of 1.5%.
More importantly, the RBA retained its neutral bias by repeating that policy is consistent with “sustainable growth in the economy and achieving the inflation target over time”. And the new comment that “further progress in reducing unemployment and having inflation return to target is expected, although this progress is likely to be gradual” suggests to us that the RBA is in no hurry to raise interest rates.
The missing pieces of evidence for the rate-hiking case remain stronger outlooks for wage growth and underlying inflation.
Our view remains that economic growth is more likely to be close to 2.5% this year than the 3.0% the RBA expects and that underlying inflation will stay below the 2-3% target for another two years yet.
Raising interest rates at this point would just make things more difficult for the Bank by strengthening the dollar, crimping business investment just as it got going, hurting households when income growth is still low and it would be tantamount to taking an axe to the housing market rather than the scalpel used by APRA. Today’s new comment that “progress is likely to be gradual” suggests the RBA understands this.
We doubt interest rates will rise at all this year. In fact, the first hike may not be until late in 2019.
Michael Workman, Commonwealth Bank
Today’s statement was a little more upbeat than those in late 2017. The synchronised pick up in the major economies is continuing and that is generally favourable for Australia’s growth outlook. The relatively benign local inflation trends give the RBA plenty of time before they need to consider altering current cash rate settings. If waiting longer stops the Australian dollar moving consistently above US 80 cents, it will help the economy grow at a respectable rate. There is still considerable slack in Australia’s product and labour markets.
We expect the RBA to leave the cash rate at 1.5% until November. Wages and inflation developments are forecast benign. Current market pricing has the first rate rise fully priced in around March 2019.
Su-Lin Ong, RBC Capital Markets
We are not surprised by the underlying optimism in today’s statement given the global backdrop and shifting stance by global policy makers. Senior RBA and government officials have spent part of the last month with their counterparts at various international meetings including the IMF. Domestic data have been mixed, but the suite of key labour market indicators has been strong. Q4 CPI confirmed sub-target inflation and little momentum, but the RBA will remain hopeful that ongoing employment generation and firmer activity will eventually lift this. This will be captured in largely unchanged macro forecasts in the SoMP.
We think this will emerge but likely take longer than the RBA’s base case given a softening housing market, tepid wages growth, and patchy consumer. The RBA has time on its side given the starting point for inflation and we expect it to be patient and stay on the sidelines throughout 2018.
In our opinion, the key risk to this view remains the global backdrop. Upside surprises to global labour markets and activity and a faster and more broad-based shift by central banks away from accommodative settings could see the RBA join its global counterparts later in 2018.
Callam Pickering, Indeed
It’s been almost two months since we last heard from the RBA but it is clear that little has changed on the rates front. Labour market conditions and inflation remain the key for monetary policy. Recent employment growth has been stronger than anticipated and data on job advertisements has certainly been encouraging. Wage growth, however, remains persistently low and hasn’t yet responded to improved business conditions.
We believe that inflation will remain either below or near the bottom of the RBA’s 2-3% inflation target until wages begin to pick-up. We see wages growth gradually improving the second half of 2018 but evidence from overseas suggests that the unemployment rate may need to dip below 5% before wages begin to respond.
Since any improvement in wages will be gradual, taking place over a number of years, we see no justification for a pre-emptive rate hike by the RBA. In fact we consider an early move particularly risky given the recent decline in Sydney dwelling prices, the strength in the Australian dollar and lackluster growth in retail sales.
While we are certainly encouraged by improvement in the labour market and a stronger outlook for non-mining investment, along with the ongoing recovery in the global economy, we believe that Australia’s economic recovery still has a long way to run. The RBA won’t make a move unless they certain that the economy can thrive under higher rates. At the very least, they want to avoid an embarrassing situation where a rate hike has to be immediately reversed because of its impact on the economy.
David Plank, ANZ Bank
Given the run of data since December, the RBA’s confidence in the outlook has lifted notably, with the bank seemingly set to lower its unemployment forecast. But perhaps the most interesting aspect of the Statement is the insertion of a new sentence into the final policy paragraph: “Further progress in reducing unemployment and having inflation return to target is expected, although this progress is likely to be gradual.”
One possible interpretation is that it is a signal that policy won’t be adjusted until core inflation is within the target band. Alternatively, it could simply be viewed as a summary of what has come before. We need more context from the RBA before we can be certain about the right interpretation — possibly from the Governor at his speech on the evening of 8 February, the RBA’s Statement of Monetary Policy (SoMP) on 9 February or in the minutes for the February meeting on 20 February.
Before we get this additional context we think we need to conclude that the RBA’s reference to the target band weakens our case for a May rate hike at least somewhat, without ruling it out, as does the removal of the RBA’s comment about the growth in housing debt outpacing that of income.
Paul Brennan and Josh Williamson, Citibank
As we expected the RBA left policy guidance squarely neutral. Forecasts for GDP were broadly unchanged, with the Bank noting that data over summer remained consistent with their outlook for the economy. The RBA continues to look favourably on business conditions and the positive boost to the economy from public infrastructure investment.
The ongoing soft spot remains the consumer. Retail trade growth is on average slow but still positive and consistent with the RBA’s view of the sector
Comments on inflation highlighted the importance of unit labour costs. We have said for some time that the RBA pays close attention to national accounts measures of unit labour costs. They are a leading indicator of overall inflation.
Market volatility in recent days supported the delivery of another neutral policy statement. We are very comfortable with our view that the RBA will keep policy unchanged until the very end of 2018.
Sarah Hunter, BIS Oxford Economics
The Board are continuing to look for evidence of improvement in household income growth, particularly in wages growth which will ultimately drive underlying inflation back into their target band. They’ve signaled that they expect it to take ‘some time’ for wage growth to pick-up — we are less optimistic, and think it will be the second half of 2019 before wage increases significantly outpace inflation.
We are also concerned about the coming downturn in residential construction, and expect a more marked drop in activity than the RBA forecasts suggest. Given this and the weakness in consumer spending, GDP growth is likely to be stuck around 2.5% this year and next.
Against this backdrop, we don’t see the Board raising the cash rate until the second half of 2019.
Annette Beacher, TD Securities
The balanced tone [of thew statement] was familiar: the pickup in global growth is supporting commodity prices, and closer to home, a strong labour market and upbeat public and private investment outlook are all expected to lift wages and inflation in due course. The weak spot is the Bank’s ‘usual’ concern about low income growth and high household debt generating tepid household consumption.
The Bank hinted that Friday’s quarterly Statement on Monetary Policy will not contain forecast changes. GDP growth is expected to be “a bit above 3%” while headline inflation is expected to be “a bit above 2%”. The Bank’s November end-2018 forecasts were 3.25% and 2.25% respectively, hinting at no change to the outlook.
Our base case is for the RBA to begin removing outsized monetary accommodation in May, but we have lost conviction on this call as some data reports have underwhelmed, including December quarter CPI, and so we await the wages report. If wage growth does not continue on an upward path towards 2.5% year-on-year, we will consider pushing out the timing of our first hike from May to August.
Diana Mousina, AMP Capital
Despite a positive outlook on the economy, the RBA has expressed no urgency in lifting interest rates. This is because there are currently greater risks to the economy if the RBA hiked interest rates compared to keeping rates on hold. The consumer sector remains weak and would struggle with higher interest rates as wages growth continues to run around a record low, household debt is at a record high and there are risks to household wealth from declining home prices, particularly in Sydney and Melbourne. The elevated Australian dollar is also putting downward pressure on exporters. The economy needs to be stronger before higher interest rates can be absorbed.
While the US Federal Reserve is in the process of tightening monetary policy, this doesn’t mean that rates have to increase in Australia. The RBA sets interest rates based on Australian economic conditions, which can move at a different pace to offshore.
We remain comfortable with the view that the RBA won’t start raising rates until the end of this year, as it waits to see a lift in inflation and a further reduction in the unemployment rate, but this process will be “gradual” over 2018, as the RBA noted in its post-meeting statement.
David de Garis, National Australia Bank
In the final paragraph the RBA now specifically reference their expectation of winning further progress in reducing unemployment and inflation back to target, if gradual. That’s expressing a greater degree of confidence in the outlook also resonating in other parts of the release, confidence that’s been emerging for a period of time.
Accumulating evidence on the global and domestic economies has also added a degree of greater confidence in the improving growth outlook and hints of optimism in returning inflation to target. There is no sense of a material change in their growth and inflation forecasts, but they do specify in the inflation paragraph they expect CPI inflation to be a bit above 2% in 2018. While their November SoMP forecast 2.25% for headline inflation to December 2018, optically, this further addition today very much plays to a developing degree of confidence in the outlook.
The RBA is on hold now pending evidence of a decline in the unemployment rate toward NAIRU, narrowing spare labour market capacity. An unexpected spike in wages and/or inflation surprise could speed up that policy activation process.
NAB’s forecast calls for the RBA to begin a gradual lifting of interest rates in H2 2018, a forecast dependent on further tightening in the labour market or evidence of inflationary pressures.