RBA will stick to positive forecasts but risks are mounting: Bill Evans

RBA will stick to positive forecasts but risks are mounting: Bill Evans
RBA will stick to positive forecasts but risks are mounting: Bill Evans


The Reserve Bank Board meets next week on November 6.

The Bank will also release the November Statement on Monetary Policy on November 9.

Of course the Governor will announce that there has been no change in the cash rate.

Readers will be aware that Westpac adopted a “no change” call for both 2018 and 2019 back in September 2017. At that time markets were pricing in three hikes by end 2019.

Today, markets are pricing only the probability of around 50% of one hike by end 2019 and a full 25bps is not priced-in until end 2020.

Back in August this year, Westpac forecast that the cash rate would remain on hold in 2020.

So, while a year ago we were offering readers some forecasts that were significantly at odds with market pricing, our views today are now largely factored in by the market.

That does not mean that our views are universally supported. In the latest Bloomberg survey of economists’ forecasts, only 10 of the 24 forecasters expect the cash rate to be on hold (one is calling cuts) by end 2019. In addition, 9 of those 13 forecasters expecting rates to be rising expect multiple hikes. Note that the other three major Australian banks expect rate hikes next year.

So the case for rates on hold is certainly not a universally accepted one.

As usual we will scour the Governor’s statement next Tuesday for any hints towards a firmer tightening bias, but there is unlikely to be much to encourage these efforts.

The Statement’s themes will be the same: continuing global expansion; China slowing a little; international trade uncertainty; Australian growth to average a bit above 3% in 2018 and 2019; positive business conditions; household consumption a source of uncertainty; labour market outlook positive; wages growth low; but a gradual lift in wages growth expected; further gradual decline in the unemployment rate expected; inflation higher in 2019 and 2020; housing conditions in Sydney and Melbourne continue to ease; progress toward full employment and target inflation will be gradual.

The Statement on Monetary Policy will include an update of the Bank’s forecasts out to December 2020.

Forecasts for GDP growth are likely to be unchanged from the August Statement on Monetary Policy: 3.25% in 2018 and 2019; and 3% in 2020. These forecasts indicate above potential growth, which is generally accepted to be 2.75%.

Headline Inflation forecasts in August were 1.75% in 2018; 2.25% in 2019; and 2.25% in 2020.

With higher petrol prices than were expected in August, the RBA may raise its forecast for headline inflation in 2018 from 1.75% to 2%.

Underlying forecasts for inflation were 1.75% in 2018; 2% in 2019; and 2.25% in 2020.

These forecasts are likely to be unchanged.

On October 31, we received the Inflation Report for the September quarter of 2018. The key underlying measures would have disappointed the RBA. The annual pace of the average of the core measures further slowed to 1.7% from the 2.0% pace in the March quarter. The six month annualised pace of the core measures is now 1.5% - the slowest pace since September 2016.

Recall that in May 2016, the then Governor Stevens was expecting 2.5% for core inflation through 2016 but revised that down to
1.5% following the release of the March quarter CPI. The Governor responded to that shock with a rate cut of 25 basis points in May and another in August.

At that time, the 6 month annualised pace of core inflation registered 1.4% through the March quarter and 1.2% through the June quarter. So momentum in inflation was indeed lower than current momentum but not by a significant margin. The longer the subdued 1.5% momentum continues, the harder it will be to justify the forecasts of 2% in 2019 and 2.25% in 2020.

One aspect of the detail within the September quarter 2018 CPI result that stood out was the sharp fall in the price pressures associated with house building. This component, which has the biggest weight in the CPI and consistently appears in the core measures, slowed from 0.8% in the June quarter to 0.1% in the September quarter.

We had a similar result for the March quarter in 2016 (0.2%)
but the measure bounced back 0.9% in the June quarter as the housing market recovered through 2016 in response to the May and August rate cuts. Between March 2016 and December 2016 new lending to property investors lifted by 40% and house prices in Sydney (up 11%) and Melbourne (up 7%) both boomed in the last six months of 2016.

There will be no such recovery in 2018 or 2019. The RBA has made a clear commitment to holding the cash rate at the current level and bank lending policies continue to tighten and house prices in Sydney and Melbourne are likely to fall through 2019.

As a comparison with 2016, we note that new lending to investors has fallen by 27% over the last year and there is no sign of any relief.

It is entirely reasonable that builders in the process of constructing new residential developments in Sydney and Melbourne will find great difficulty in passing on cost increases as this particular component of the CPI has remained weak for many quarters. Supply is also likely to maintain downward pressure on rents which are another key component of the CPI.

We would not expect the RBA to incorporate such concerns in their forecasts. They will continue to forecast rising inflation out to 2020 despite the risks around housing as well as the ongoing threat to inflationary expectations as the headline rate stays well below the 2.5% target (on a calendar year basis headline inflation has been below 2% since 2014).

The final forecast which appears in the SOMP will be for the unemployment rate.

The forecast in the August SOMP were for a gradual decline to 5.25% in December 2019 continuing to 5% in December 2020.

That was always a very awkward forecast for the RBA which is promoting the prospect of rising wage pressures particularly through 2019 and 2020.

For Australia, the “full employment” rate estimate is generally considered to be 5.0% but we have found that in other developed economies (particularly the US and UK) the full employment rate is lower in the current cycle than that historically. In the US, the unemployment rate has fallen to 3.7% (well below the previously accepted full employment rate of 4.75%) yet wage pressures are only just beginning to emerge, (the Employment Cost Index has lifted by 2.8% in the year to September).

It seems highly unlikely that in this current world of increasingly rapid technological change; globalisation; risk aversion of employees; low inflationary expectations and low trade union membership that Australia’s full employment rate is 5%.

With the current print (September) on the unemployment rate now at 5.0% (compared to 5.5% in the August SOMP) the RBA is expected to lower its 2020 unemployment forecast to 4.75%.

Note that the RBA use the three month average of the seasonally adjusted monthly unemployment rate estimate, which is currently 5.2%, as their latest read. That recognises the volatility in
monthly estimates and the potential for the recent sharp fall in the unemployment rate to reverse somewhat over the next few months. Abstracting from the short-term particulars, the core profile of the forecast will be consistent with the key theme of a “gradual decline in the unemployment rate”.

In contrast, Westpac’s forecast reflects a likely slowdown in jobs growth in 2019 with the unemployment rate ticking up to 5.3% through 2019 before settling back at 5.0% by end year. In 2020 we would broadly concur with a 4.75% unemployment forecast by end 2020 although would not see that level as full employment.

Note that the August SOMP discussed the dynamic around the wealth effect as a risk but not a central theme driving the forecasts.

“Recent declines in national housing prices have been gradual and follow several years of very strong growth. Accordingly, there is no evidence that moderate housing price declines have weighed on household consumption to date. Nevertheless, housing assets account for around 55 per cent of total household assets, so lower housing prices could lead to lower consumption growth than is currently forecast. Although the earlier gains in national housing wealth may not have encouraged much additional consumption, it is possible that the consumption decisions of highly indebted and/or credit-constrained households could be more sensitive to declines in housing prices than to the previous increases.”

We expect this issue to remain a risk in the November SOMP but not a factor incorporated into the forecasts.

We view that risk as being much more likely and a central component behind our growth forecasts.

Westpac expects growth in 2019 to slow from 3.3% in 2018 to 2.75% in 2019.

BILL EVANS is chief economist of Westpac.


Forecast Bill Evans

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