Next move in interest rate is "up": Savanth Sebastian

Next move in interest rate is
Next move in interest rate is "up": Savanth Sebastian

The Reserve Bank Governor’s commentary was similar to the Monetary Policy Statement released a fortnight ago.

However his comments today provided more clarity and reinforced our view that interest rates are likely to remain on hold over the next 12 months.

Interestingly the question and answer time highlighted the pragmatic approach the central bank takes in discussing an array of topical issues.

When prompted by parliamentarians about the discussion in the recent Reserve Bank Board meeting on the neutral cash rate, the Governor highlighted that markets will always react to what is said, but the decision to discuss the neutral cash rate setting at the July Board meeting was made earlier this year.

And the message that the Governor wanted to get across was that “it was a reasonable assumption that the next move in interest rates was up rather than down but it is some time away” and the neutral setting for the economy is lower than where it has been in the past.

The Governor made comments on business investment saying it was being held back by a range of uncertainties such as global politics and some domestic policy settings.

Given the strength in the business conditions, the central bank has “been looking for a strong pick-up in private business investment outside the resources sector. This is taking longer to occur than expected”.

And the RBA believes that this reluctance to commit to significant investment could possibly continue for some time yet.

No doubt the level of commitment by businesses to invest in the economy will be watched very closely by policymakers and be a key metric in the outlook for interest rates.

Interestingly, there was a lot of robust discussion on a variety of issues ranging from the mechanisms to control house prices, the growth of household debt, payments systems, Australia’s infrastructure spending, the benefits of a lower Australian dollar, even the cost of electricity prices, penalty rates and tax reform.

Certainly there is a lot that is occupying policymaker thoughts at present.

Overall the Reserve Bank Governor was more optimistic on the medium term outlook for the Australian economy.

Highlighting that even when it comes to mining investment the pullback is almost complete.

The focus now is to ensure an ongoing lift in non-mining business investment to support medium term growth objectives.

CommSec expects no change to interest rates over next year.

Below are the comments Philip Lowe made in regards to various topics.

On economic assessments, "There has been an improvement in survey-based measures of business conditions and capacity utilisation has increased.

“Employment growth has also picked up and retail spending has been a bit stronger of late. Financial conditions remain favourable, with interest rates remaining low and banks willing to lend”.

“In summary, our central scenario is for GDP to grow at an average of around 3 per cent over the next couple of years.

“This would be better than we have seen for some time.”

On business investments, “For some time we have been looking for a strong pick-up in private business investment outside the resources sector.

“This is taking longer to occur than expected.

“While we do see positive signs in parts of the economy, many firms still show some reluctance to commit to significant investment, often citing a range of uncertainties.

“It is possible that this reluctance will continue for a while yet.

“But it is also possible that the improvement in business conditions that we have seen will give firms the confidence to invest more, after a period of under-investment.

“We have incorporated a middle path into our own forecasts.”

On the household sector, “There is an adjustment going on, with many people getting used to lower growth in their real wages.

“Many now see this as more than just a temporary development, with wage increases of 2 point something per cent now the norm.

“In my view, the underlying drivers of the slower wage growth in Australia are much the same as we are seeing overseas.

“At the same time, the household sector is also dealing with higher levels of debt relative to income.

“Higher electricity prices are also affecting household budgets.

“This all means that consumer spending behaviour is something we continue to watch carefully.”

On economic transitions, “The transition to lower levels of mining investment following the mining investment boom is now almost complete.

“This means that falling levels of mining investment will not be a drag on the economy for much longer.

“Instead, with some large LNG projects reaching completion soon, GDP growth is expected to be boosted by a lift in LNG exports”.

On China, “In China, growth has surprised on the upside a little of late.

“The main challenge there continues to be containing the risks from the build-up of debt, while at the same time keeping growth on a steady path.

“This remains a work in progress.”

When asked about the outlook for wages Philip Lowe replied that he hopes to see the annual wage grow by 3.5% over time, inflation 2.5% and productivity 1%.

He also believes that we should be capable of achieving “3-point-something” annual wage growth.

On wage growth he said, “There is an adjustment going on, with many people getting used to lower growth in their real wages.”

“Signs wages are picking up for some construction and IT jobs due to stronger demand for workers”.

He also stated that it was up to the Government to improve structural things such as tax policy, competition policy and education reform.

On prudential housing measures he stated, “I think we have done enough for the time being.”

He reasonably assumed that the next move in interest rates is up, “but quite some time away,” however the average cash rate in the future will be lower than in the past due to lower real rate.

On the level of household debt Philip Lowe stated, “We are cognisant of the high level of household debt and take it into consideration when deciding on policy.”

In terms of inequality he believes that Australia is doing better than other countries and while the productivity is not growing fantastically, it is not doing bad either.

For prices he says that there are lots of prices in the consumer price index that are weak such as food and clothing.

Energy prices are affecting business investment; household budgets and will affect CPI.

He also commented about full time employment saying that an unemployment rate as somewhere around 5%, but he doesn’t see that happening in the next three years.

The latest comments from the Reserve Bank Governor support the view that interest rate settings will be stable for some time yet.

While Governor Lowe said that had a number of areas are being watched closely, from the strength in Chinese demand, to rising Australian dollar, investment and rising household debt.

There are no signs of imminent action on rates.

Savanth Sebastian is a senior economist for CommSec.

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