Cash rate will remain on hold in 2018 and 2019: Westpac's Bill Evans
The minutes of the monetary policy meeting of the Reserve bank Board on 5 December contains some noteworthy changes in the wording relative to the November minutes.
In describing the key issue for the Board, the following sentence was used in the concluding paragraph: “how far, and when, stronger conditions in the economy and labour market might feed through into higher wage growth and inflation remained important considerations shaping the outlook”.
The sentence was used “the Board judged that holding the stance of monetary policy unchanged at this meeting would be consistent with sustainable growth in the economy and achieving the inflation target over time”. This is the same wording that was used at the conclusion of the minutes to the October meeting, whereas in November “at this meeting” was excluded. A reasonable person might interpret the decision to include “at this meeting” as indicating a greater urgency about moving policy. However, we notice that this term has been used intermittently over the course of 2017 (March, June, July and October). Consequently it would be inappropriate to read anything into the use of this term.
The Board maintains its forecast that wage growth will “increase gradually over the next year or so”. But, of course, we are aware of the official forecasts that underlying inflation will hold at 1.75% in 2018, only lifting to 2% in 2019. As we have seen in recent speeches from the Governor, much store is being given to surveys which indicate that “more firms had been reporting difficulty in finding suitable labour”. This is not surprising given that full-time employment is currently growing at around its fastest pace in a decade although this is partly offset by the rise in the participation rate, leaving the unemployment rate at 5.4%, still well-above the generally accepted full-employment level of 5%.
The Bank seems somewhat tentative that the current strong labour market will continue with the outlook indicating that “employment growth would be somewhat above average over the next few quarters”.
Other encouraging signals from the economy continue around business investment with “investment intentions had been revised higher, particularly for the business services sector."
At the meeting the Board was also presented with scenarios under which public investment was higher than currently forecast over the following three years. These scenarios were encouraging, particularly around higher profits; worker’s incomes; productivity; and private investment prospects. With housing markets slowing substantially, the finances of state governments are likely to come under some pressure with the expected result that scenarios for public investment lifting even further than currently expected seem unlikely to prove accurate.
Of course, the source of concern remains the consumer. The meeting occurred the day before the release of the September quarter national accounts which showed that consumer spending growth slowed to the weakest we have seen since the December quarter 2008. The minutes report that “household consumption continued to be a significant risk, given that household incomes were growing slowly and debt levels were high”. This is a more concerning description of the outlook compared to November which used the term “uncertain.”
The slowdown in the Sydney housing market is recognised with prices declining. House price growth was reported as easing in Melbourne, while prices in Perth and Brisbane had been unchanged. The minutes note that “growth in household credit had slowed somewhat, but members agreed that household balance sheets still warranted careful monitoring”. It is worth noting that in response to a question around household leverage which I asked the Governor at a public dinner on November 21, he noted that household credit growth of around 6% was “okay”.
The developments described in the minutes are consistent with our own view that household credit growth will slow to around 4½% in 2018, still modestly boosting household leverage due to ongoing weak income growth but not representing any threat to financial stability.
In the Governor’s statement following the December 5 Board meeting, he changed the wording around the Australian dollar to indicate that there was no longer any official sensitivity around the level of the AUD; “the Australian dollar remains within the range that it has been in over the past few years”. The minutes provide a little more colour on this issue, noting that “members noted that while the Australian dollar had depreciated by around 5% in trade weighted terms over this period (November) it had moved within a relatively narrow range over the previous 2½ years and was a little higher than the level of early 2016”. This confirms the reasonable view that the Bank is relatively comfortable with the current level of the AUD.
Despite a generally upbeat assessment of the world economy, the minutes confirm that the Bank still expects Australia’s terms of trade to fall over the forecast period. No doubt the Bank’s ongoing caution around China is a factor here. The minutes point out a tightening in financial market conditions in direct response to managing risks in the shadow banking sector. These concerns around China’s financial stability have been a consistent theme from the Bank for some time.
Conclusion:
The concluding paragraph in the minutes clearly lays out the compass for policy. Strength in the labour market and expected associated spill-over effects is expected to continue, although policy will only be adjusted when it is clear that wage and price pressures return.
Westpac has a more cautious view on the sustainability of the current jobs and business environment while expecting that soft income growth and high debt levels will continue to constrain the consumer. We note that even the RBA now describes household consumption as a “significant risk”. Accordingly, we do not expect to see the necessary conditions which are outlined by the RBA to emerge over the course of 2018.
We retain our view that the overnight cash rate will remain on hold in 2018 and 2019.
BILL EVANS is chief economist of Westpac.