Confusion on the RBA's growth forecast for 2018

Expert Observer

As expected, the Minutes of the March Monetary Policy Meeting of the Reserve Bank Board provided no real surprises although from our perspective there is some confusion as to the Bank’s growth forecast for 2018.

When the Governor made his statement following the Meeting, he changed the growth assessment for 2018 from “a little above 3%” to “faster than 2017”. That appeared to be a substantial change given that the expectation was that growth in 2017 (to print the following day in the December quarter GDP report) was expected to be only 2.5%. In today’s Minutes, we get a third variation where growth in 2018 is described as “expected to exceed potential growth”.

Potential growth is assessed by the RBA as 2.75%. So, we can conclude that despite sending somewhat different signals, the Statement and the Minutes are both pointing to a somewhat lower growth outlook for 2018. Note that the forecast for the February Statement on Monetary Policy was 3.25% and we will receive the next forecast on May 4.

The discussion around consumption is little changed. There is still “uncertainty surrounding the outlook for consumption growth”. Note that this meeting did not have the advantage of knowing the substantial upward revision for consumption in 2017. Based on partials, it was reasonable to expect consumption growth in 2017 to be around 2.2%.

The final number printed 2.9%. In response to that faster momentum, Westpac has revised up its GDP forecast for 2018 form 2.5% to 2.7%. However, we still expect growth of 2.5% in 2019, indicating a slowdown in the economy in that year. Even with this faster actual consumption path in 2018, we still think the Bank will remain uncertain around the consumption outlook, particularly given the reference to the impact of high household debt levels on consumption.

There is a special consideration of the switch from interest-only to principal and interest loans, and the associated impact on borrowers’ cash flows. The Board notes that “the increase in payments would be significant for some individual households”, but concludes that this impact represents “a small proportion of household disposable income”. We concur with that assessment.

There is a long discussion on the outlook for business investment, concluding that there may be some upside risks to the Bank’s forecasts in growth in non-mining business investment over the medium term.

The discussion on the labour market continues to be dominated by the word “gradual”; “wages growth was expected to rise gradually and spare capacity in the labour would continue to decline gradually”.

Housing markets in Sydney and Melbourne are recognised to have slowed and housing credit growth had eased, particularly under the weight of tighter credit standards. However, the Board is not fully satisfied and still noted that household balance sheets continued to warrant “careful monitoring”.

It is noteworthy that the Minutes assess financial market pricing as indicating that the cash rate is expected to remain unchanged during 2018 with a 25bps increase expected in the first half of 2019.

Commentary around the Australian Dollar is unchanged “on a trade-weighted basis, the Australian Dollar remained within its range of the preceding two years”. Overall conditions in the global economy are assessed as continuing to improve with a broadly based upswing. Nevertheless, the minutes repeat the Bank’s long-held view that Australia’s terms of trade are likely to “decline over the following few years”.

Conclusion

Given that the national accounts were not available at the time of the Board meeting, it is not certain that the Bank has decided to lower its 2018 growth forecast from 3 ¼ per cent. Certainly, Westpac assessed the December quarter report as justifying a modest lift in our growth forecast from 2.5% to 2.7%. A growth forecast of 3 ¼% in an economy where potential is 2.75% would normally be associated with a central bank that expects to tighten policy at some stage over the course of the year. We certainly have believed that the Bank held such an expectation.

The ongoing emphasis on “gradual” with regard to the labour market and inflation increase the probability that the Bank is reassessing that view. It was always our expectation that such a reassessment would occur over the course of 2018.

We continue to expect that the cash rate will remain on hold in 2018 and 2019.

With growth slowing to below trend in 2019, we cannot see a case for higher rates in that year either.

BILL EVANS is chief economist of Westpac.