RBA minutes show importance of inflation to rate cut decision: Westpac's Bill Evans

GUEST OBSERVER

The minutes of the May monetary policy meeting of the Reserve Bank Board provide only one additional insights to the Statement on Monetary Policy (SoMP) which printed on May 6.

This insight is in the final paragraph of the “Considerations” section where it emphasised the closeness of the decision to cut the overnight cash rate using the qualification, ”members discussed the merits of adjusting policy at this meeting or awaiting further information before acting.” This wording which may be interpreted as a truism is, nevertheless, not always used and would therefore cast considerable doubt on prospects for a follow up move before our preferred date of August when further information on inflation will be available.

In the SOMP and repeated in these minutes the following key observation was made: “Members noted that developments over recent months had not led to a material change in the outlook for economic activity or the unemployment rate but the outlook for inflation had been revised lower.” The Board also noted that developments in the housing market represented less risk of overstimulating with a further rate cut.

The discussion on inflation highlighted the following points – “weakness in domestic cost pressures had been broadly based reflecting low growth in labour costs and a range of other factors including heightened retail competition, a moderation in conditions in housing rental and construction markets and declines in the cost of business inputs such as fuel and utilities”. It was also noted that low wage growth and heightened retail competition appeared to have limited the extent to which importers were passing on higher import prices to retail prices.

Particular emphasis is given to subdued growth in labour costs (a bit weaker over 2015 than expected). It is important to note that the Bank’s forecasts embody the expectation that growth in the wage price index will stabilise around current rates before gradually picking up later in the forecast period. Bank liaison suggested that firms had been unwilling to make offers of wage growth below 2%. In this regard the next wage price index which prints tomorrow will be closely watched. Westpac expects a 0.4% print down from 0.5% last quarter and 0.6%’s in previous quarters – if correct this result will certainly unnerve the authorities although, in our view, not sufficiently to trigger a rate cut before our current timing of August by which time the Bank will have received the full picture on price developments from the June quarter inflation report.

As discussed above the inflation outlook was the only real change from previous assessments. Employment is expected to continue to grow at a slower pace than had been evident over the previous year and the unemployment rate was expected to remain around 5¾% over the next year or so before gradually declining. This outlook is broadly in line with that set out in February and from our perspective is somewhat cautious. For example, Westpac expects the unemployment rate to have edged down to 5.4% by mid next year.

Consistent with the Bank retaining its 3% growth forecasts for 2016 and 2017 in the May SoMP the commentary around the overall real economy is broadly unchanged. Further strong growth in dwelling investment is expected; house prices are expected to grow moderately; indicators of business investment intentions remain weak with non-mining investment only forecast to gradually pick up later in the forecast period and the magnitude of mining investment was expected to diminish over the next couple of years.

At the time of the May Board meeting the AUD was around USD 0.76 and TWI 63.3 prompting the following observation in the minutes: “the exchange rate depreciation since early 2013 was assisting with growth and the economic adjustment process, although an appreciating exchange rate could complicate this.” That compares with USD 0.73 and TWI 61.4 today, providing the Board with considerable comfort around the impact of the AUD on Australia’s growth prospects.

As discussed in the SoMP the Bank appears to be increasingly nervous about China. While recognising the short term impact of more stimulatory policy settings the minutes conclude that these actions might adversely affect financial stability and the economic outlook in China more broadly in the medium term.

There would also appear to be a scaling back in the RBA’s expectations for US Federal Reserve policy. Rather than refer to the Fed’s tightening cycle the minutes now choose to quote market pricing which implies at most one 25bp increase in the Federal Funds rate during 2016.

Conclusion

It is difficult to see any significant additional insights in these minutes relative to the more comprehensive Statement on Monetary Policy.

With reasonable prospects for ongoing above-trend growth we expect that the Bank will be satisfied that its next rate cut in August will provide further support for its current forecast that underlying inflation will be back near the bottom of the target zone in 2017. However, clearly with the evidence of today’s minutes emphasising the importance of the inflation outlook, risks to our current forecast must remain to the downside.

Bill Evans is chief economist of Westpac.