Reserve Bank retains neutral bias, no significant change in commentary: Westpac's Bill Evans

GUEST OBSERVER

As expected, the Reserve Bank Board decided to leave the cash rate unchanged at 1.5 percent.

It is significant that the Governor chose to retain the same language as used in October for the concluding paragraph which signals any bias. The neutral bias which we saw in October has been retained in November.

In recent speeches the Governor has highlighted his overall approach to policy. That entails a 2-3 percent target for inflation “over time”. He has pointed out that with inflation currently below the bottom of that band he eventually expects inflation to move within the band. However the pace at which that movement is expected will be dependent upon the state of the labour market and the housing market.

Over the last month we received key data on employment; housing; and inflation. As we anticipated, the inflation report printed broadly as the Board expected signalling no need to adjust the policy stance for the inflation update. Recall that the Bank’s forecasts for underlying inflation in 2016 are 1.5 percent and in 2017 2 percent. The September inflation report signalled that the 1.5 percent is likely to be achieved and our analysis indicated that there was some evidence that we have passed the low point in inflation although the pace of increase is likely to be moderate. That scenario fits with the 2 percent forecast for 2017.

The language around the labour market was almost identical to October although consistent with the disappointing September employment report the Governor noted that “employment growth overall has slowed”. However he did repeat the observation that “forward-looking indicators point to continued expansion”.

Commentary around the housing market was also broadly unchanged although the language describing the activity in Sydney and Melbourne was strengthened from “some markets have strengthened recently” to “some markets have been rising briskly”.

International commentary, specifically around China, has changed. In October the Governor noted that the “underlying pace of growth in China has been moderating”. He now recognises that recent data has improved but points out that “medium term risks to growth remain”. That sentiment is consistent with the detailed analysis in the Financial Stability Review of the risks emerging in the Chinese banking system as the small private sector banks grow rapidly with over reliance on short term funding and a generally increasing exposure to complex investment assets.

Conclusion

We are not surprised by this decision and Statement. It is entirely consistent with our view that rates will remain on hold for the remainder of this year and over the course of 2017.

As we have discussed in previous notes the inflation outlook is unlikely to be the source of any future policy adjustment.

The policy easing in 2016 has been in response to the inflation shock earlier in the year but now policy is likely to refocus on the real economy.

Our current forecast of 3.3 percent growth next year, supported by 1.6 percent growth in employment, is unlikely to signal the need for lower rates.

However, with inflation only likely to track along the bottom of the 2-3 percent target band next year there will be scope to ease further should growth, and the labour market in particular, profoundly disappoint.

That is not our forecast but we acknowledge that if rates are to move next year it will be down rather than up in 2017.

BILL EVANS is chief economist of Westpac.