Housing won't be coming to the rescue to solve the RBA's inflation problem

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  • Of all Australian inflation forecasters, few have had a track record as good as Westpac Bank when it comes to correctly predicting inflation trends.
  • Bill Evans, Chief Economist at Westpac, has warned that risks for the RBA’s optimistic forecasts for inflation and GDP growth are mounting.
  • Unlike 2016 when a property price and residential construction boom helped to lift core inflation from record lows, Evans says “there will be no such recovery in 2018 or 2019”.

Of all the Australian inflation forecasters we follow here at Business Insider, few have had a track record as good as Westpac Bank when it comes to correctly predicting inflation trends.

Given its recent form, including for the latest Q3 consumer price inflation (CPI) report, we tend to pay close attention as to what its economics team has to say.

Ahead of the Reserve Bank of Australia’s (RBA) quarterly statement on monetary policy (SoMP), including updated forecasts on GDP growth, unemployment and inflation, Bill Evans, Chief Economist at Westpac, has released a preview note on what to expect.

Not much, is the short answer — but with an important caveat, which we’ll get to momentarily.

“The statement’s themes will be the same,” he says.

“Continuing global expansion, China slowing a little, international trade uncertainty, Australian growth to average a bit above 3% in 2018 and 2019, positive business conditions, household consumption a source of uncertainty, labour market outlook positive, wages growth low, but a gradual lift in wages growth expected, further gradual decline in the unemployment rate expected, inflation higher in 2019 and 2020, housing conditions in Sydney and Melbourne continue to ease [and] progress toward full employment and target inflation will be gradual.”

As anyone who has been following the RBA’s commentary knows, that’s all been heard before.

So where is this going, we hear you say?

Well, although Evans says the SoMP will likely be a rehash of prior glass-half-full commentary, he thinks that behind the RBA’s optimistic facade, the downside risks for inflation are growing.

Indeed, following the release of the Q3 CPI report this week, he says the trends in core inflation aren’t all that dissimilar to what was seen in 2016, a period that actually saw the RBA act on weak inflation by cutting the cash rate twice.

“In May 2016, the then Governor Stevens was expecting 2.5% for core inflation through 2016 but revised that down to 1.5% following the release of the March quarter CPI,” he says.

“At that time, the six-month annualised pace of core inflation registered 1.4% through the March quarter and 1.2% through the June quarter.”

In the latest CPI report, the six-month annualised pace of core inflation fell to 1.5% , the weakest pace since September 2016.

“Momentum in inflation was indeed lower than current momentum but not by a significant margin,” Evans says.

“The longer the subdued 1.5% momentum continues, the harder it will be [for the RBA to] justify it core inflation forecasts of 2% in 2019 and 2.25% in 2020.”

Ominously, particularly given Westpac’s recent form, he say that one major factor that helped to boost core inflation back in 2016 will not be repeated again: a residential building and property price boom.

“One aspect of the detail within the September quarter 2018 CPI result that stood out was the sharp fall in the price pressures associated with house building,” he says.

“This component, which has the biggest weight in the CPI and consistently appears in the core measures, slowed from 0.8% in the June quarter to 0.1% in the September quarter.

“We had a similar result for the March quarter in 2016 (0.2%) but the measure bounced back 0.9% in the June quarter as the housing market recovered through 2016 in response to the May and August rate cuts.

“There will be no such recovery in 2018 or 2019.”

As those who have been following closely already know, the RBA believes, at least from public comments, that the next move in its cash rate is likely to be up, albeit not in the near-term.

Despite continued undershoots on core inflation, the RBA is clearly reluctant to cut the cash rate to help lift inflationary pressures, seemingly concerned that a further decline in interest rates would simply encourage more borrowed money to be tipped into the housing market, potentially leading to higher household leverage and, down the line, greater risks of financial instability.

Not everyone agrees that keeping the cash rate steady to prevent a repeat of what happened in 2016 is the right course of action at present, particularly at a time when macroprudential restrictions introduced by APRA have successfully cooled the housing market without the need to lift official borrowing costs.

No matter your opinion, the RBA simply doesn’t want cut rates further.

The stalemate between inflation and housing considerations at the RBA Board table is unlikely to be broken anytime soon. Given that, Evans says economic growth will slow next year to 2.75%, now regarded as Australia’s trend growth rate, keeping inflationary pressures sluggish and the cash rate unchanged until 2021 at the earliest.

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