Domestic headwinds and any hard landing in China to determine RBA call: CBA's Gareth Aird
GUEST OBSERVER
The RBA’s decision to leave the cash rate unchanged came as no surprise.
Market pricing had implied very little chance of policy easing in February, largely because employment growth has lifted and the unemployment rate has been falling.
The Governor’s Statement was the first commentary out of the RBA on the economy since mid‑December. And it deviated from the usual carbon‑copy approach that was taken for most of the post‑meeting Statements over the second half of 2015.
In summary, the Bank appears a little less optimistic on the global economy and a touch more upbeat on the domestic economy. Growth in the global economy is occurring at a “slightly lower pace than earlier expected”. And financial markets have exhibited “heightened volatility recently” and “risk appetite has diminished”.
On the domestic economy, the Governor notes that “expansion in the non‑mining parts of the economy strengthened during 2015 even as the contraction in spending in mining investment continued”.
The Bank has acknowledged the marked improvement in the labour market. Indeed, in December the Governor indicated that “stronger growth in employment” had been accompanied with a “steady rate of unemployment”. This has now been replaced by a recognition that, “the unemployment rate declined in the second half of the year” even though the economy was growing below trend. Critically, labour market developments will be the key input into near‑term policy direction (at least until the next read on inflation). The Governor noted that, “new information should allow the Board to judge whether the recent improvement in labour market conditions is continuing”. The Board will also assess whether, “the recent financial turbulence portends weaker global and domestic demand”.
On inflation, the Governor acknowledged the impact that declining oil prices and some utilities have had on headline inflation. But overall, consumer price inflation is expected to, “remain low over the next year or two”. In December, inflation was “forecast to be consistent with the target over the next one to two years”.
The Governor tweaked his commentary on the exchange rate, but the message remains the same. The AUD “continued its adjustment to the evolving economic outlook”. The AUD is currently 3.1% lower against the USD (1.8% lower on TWI basis) than it was when the RBA Board last met in December. So monetary conditions have further eased.
THE OUTLOOK
Our views on the labour market and inflation underpin our expectations that the cash rate will stay at 2.0% in 2016. Inflation should drift a little higher as exchange rate pass‑through continues, though we expect it to be at the bottom end of the RBA’s target band. On the unemployment rate, we see enough evidence in the leading indicators of jobs growth to suggest that the unemployment rate peaked in 2014. We expect it to grind a little lower over 2016.
Markets, however, are still likely to continue to price in the chance of further RBA policy easing even though we don’t expect another rate cut to materialise. This essentially reflects the balance of risks in the global and domestic economy, coupled with the RBA’s conditional easing bias.
The single biggest risk to the global economy is a hard landing in China which would have a material negative impact on the Australian economy. Domestically, the continued decline in mining investment, soft income growth and weak public demand pose the greatest headwinds on growth.
Market attention now quickly turns to the February Statement on Monetary Policy (SMP), published on Friday. In our view, the RBA is likely to leave its growth forecasts unchanged. Near‑term headline inflation forecasts are likely to be downwardly revised due to lower oil prices. But underlying forecasts should be left unchanged. We expect the RBA’s unemployment rate forecasts to be revised down.
Gareth Aird is economist at Commonwealth Bank and can be contacted here.