Why the NAB believes the RBA will continue cutting rates in 2017

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Most analysts and traders, including economists from three of Australia’s big four banks, think the next interest rate move from the Reserve Bank of Australia will be higher, not lower.

Inflation, while low, is in line with the RBA’s forecasts, and there are signs that unemployment is also trending lower, even forgiving a slight uptick in the latter parts of 2016.

Throw in rampant house price growth in Australia’s largest and most expensive housing markets, Sydney and Melbourne, and it’s seen expectations of further rate cuts slowly dissipate as financial stability concerns come the fore.

However, not everyone thinks the RBA’s easing cycle, which started in late 2011, has come to an end.

The National Australia Bank (NAB) thinks the RBA will continue to cut rates in 2017, not once but twice, leaving the cash rate at just one percent.

The reason for this call, it says, is not premised on what will happen in the year ahead, but rather what will happen in 2018. And while low inflation will play a part, it says that it’s other factors that will lead to the RBA to cut further.

Ivan Colhoun, chief economist at the bank’s markets division, explains:

The first point to make about NAB’s forecast for two further rate cuts in 2017 is this forecast is largely based on the bank’s forecast for Australian GDP in 2018 and is not especially influenced by the outlook for inflation. The latter is broadly expected to remain very low given the restraining influence of rents on core inflation and the substantial amount of new housing supply coming on stream, which in turn is expected to keep rental growth low for a sustained period.

The forecast was based on what NAB sees as an expected relatively weak growth outlook for 2018, which partly reflects an expected downturn in housing construction. We’ll get a further update on the trend for building approvals on Thursday this week however the thought process is that without further monetary policy stimulus later this year, the downturn in housing construction and less momentum in exchange sensitive sectors and resultant slow GDP growth would otherwise result in an increase in the unemployment rate. This is something that would be incompatible with the RBA’s charter given inflation is both running below target and is only expected to return slowly to target.

So with inflation set to remain low, and economic growth expected to slow as growth tailwinds from the lower Australian dollar, commodity exports and residential construction fade, it will lead to an increase in the national unemployment rate, adding to disinflationary forces within the economy through weak wage growth and household demand.

Colhoun says the trend for building approvals and the number of applications for each job ad “will be important indicators to see whether our forecast remains on track, along with the NAB business survey.”

But he also concedes that following last week’s Australian inflation report, and given signs that financial stability concerns are playing a more influential role in determining monetary policy settings, the hurdle for further near-term easing from the RBA “is high”.

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