RBA remains on hold; with no apparent change in sentiment: Bill Evans

RBA remains on hold; with no apparent change in sentiment: Bill Evans
RBA remains on hold; with no apparent change in sentiment: Bill Evans

EXPERT OBSERVER

As expected, the Reserve Bank Board decided to leave the cash rate unchanged at 1.50%.

This represents the twenty-second consecutive meeting (last change in August 2016) that rates have been on hold. The previous longest run of steady rates was sixteen consecutive meetings in 1995/96.

There were a number of changes/ additions to the statement following the July meeting. Previously, the Governor had noted the growth outlook being “a bit above 3 per cent in 2018 and 2019”.He repeated that line. But previously  he made no inference as to that impact on capacity. In today’s statement he asserts that the growth outlook “should see some further reduction in spare capacity”. This was borne out in the discussion on the labour market when he noted that the unemployment rate was likely to fall to around 5 per cent over the next couple of years.

Recall that in the May Statement on Monetary Policy, the Bank revised its unemployment forecast from 5 ¼ per cent (end 2018) and 5 ¼ per cent (end 2019) to 5 ½ per cent (end 2018) and 5 ¼ per cent (end 2019). The forecasts that will be updated in the August Statement on Monetary Policy which will be released on August 10 are now likely to include a forecast that the unemployment rate by end 2020 will be 5 per cent. A reasonable criticism of the Bank’s unemployment forecasts and rhetoric around increasing wages growth was that a low-point of 5 ¼ per cent was still comfortably above the generally accepted NAIRU for Australia of 5 per cent. With the unemployment rate staying above the NAIRU, it was questionable as to whether the expected lift in wages growth would occur.

Our view, based on offshore evidence, is that the NAIRU in this cycle is likely to be below 5 per cent, so even with this new lower unemployment forecast, it still seems a big call to expect sustained upward pressures on wages growth.

In July, the Bank noted the increase in short-term wholesale interest rates over recent months. However, it provided little guidance as to the implications. “It remains to be seen the extent to which these factors persist”. Fortunately, that sentence has been deleted, but, still, no real guidance is provided in the current statement. It is observed that retail deposit rates have not risen and some lenders have increased mortgage rates by small amounts. It would have been helpful for the Bank to have given its own view on the sustainability of this move and any implications from the associated tightening in financial conditions.

The Governor notes that “the drought has led to difficult conditions in parts of the farm sector”, but has not clarified whether these developments have any significant implications for risks and growth forecasts.

The August Statement has the benefit of an update on inflation developments. The June quarter inflation report was slightly below market expectations but not sufficient to alter the Bank’s views. Having said that, a literal interpretation of the sentence “the central forecast is for inflation to be higher in 2019 and 2020 than it is currently” would be that the forecasts for inflation in the August Statement on Monetary Policy are set to be lifted. The forecasts for underlying inflation in the May Statement on Monetary Policy were for underlying inflation to be 2 per cent in 2018 and 2 per cent in 2019. That outlook seems consistent with the June inflation report. We would be surprised if the forecast for underlying inflation in either 2018 or 2019 is lifted in the August SOMP.

One clue to this puzzle is that the Governor points out that headline inflation to the September quarter is likely to fall to 1 ¾ per cent. As such, the forecast for headline in the May SOMP of 2 ¼ per cent in 2018 and 2019 indicates a lift from the expected September reading. Such fluctuations in the headline number are unlikely to have any implications for policy.

In July, the Governor referred to “nation-wide measures of housing prices are little changed over the past six months”. The CoreLogic national index was actually down 1% and this index is now down by 1.2%. That sentence has not been repeated in the August Statement, although the easing in Sydney and Melbourne housing markets is confirmed. The Governor has also dropped the comment that “some further tightening of lending standards by banks is possible” and now makes the less controversial comment that lending standards are tighter than a few years ago.

There has been a significant change in the global commentary. In July, the Governor noted “the Chinese economy continues to grow solidly”. In this statement, that is replaced with “growth in China has slowed a little, with the authorities easing policy”.

Conclusion

Westpac has long held the view that the RBA cash rate will remain on hold over the course of 2018 and 2019.

In his statement, the Governor does not provide a convincing commentary that wage pressures can be expected to lift; the housing slowdown and the associated wealth effect will not be headwinds for the economy; any evidence that inflation pressures are likely to build; and why global developments are not pointing to some challenges for Australia. Consequently we see no reason to be persuaded to change our view that rates will remain on hold.

Bill Evans is the Chief Economist for Westpac

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cash rate Reserve Bank

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