RBA will be surprised with slowdown in economy: Westpac's Bill Evans

EXPERT OBSERVATION 

As expected, the Reserve Bank Board decided to leave the cash rate unchanged at 1.5%.

The themes that have become familiar in previous statements were repeated in this one: continuing global expansion; China slowing a little; international trade uncertainty; 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.

However, the growth and unemployment forecasts have been revised. These forecasts will be confirmed in the Statement on Monetary Policy that will be released on November 9. The forecast growth rates for 2018 and 2019 have been revised up from 3.25% to 3.5%, while the 2020 forecast is for a slowdown, although the current forecast of 3% may now be revised up to 3.25%. With no real change in the wording, there is no clear justification for this upward revision, particularly for the faster expected growth in 2019.

Westpac expects growth to slow in 2019 to 2.7% reflecting a weaker consumer; a contraction in residential construction; a softening housing market; weakening global economy and some impact on business and household sentiment from the uncertainty around the federal election.

Less surprisingly, the forecast unemployment rate by 2020 has been revised down to 4 ¾% from 5%. That may be significant because 4.75% is below the generally accepted full employment rate in Australia of 5%. As such, that might imply that the Bank is more confident that significant wage pressures will be building. However, overseas evidence and measures of current slack in the labour market point to a benign wage outlook, even if the unemployment rate falls to 4.75%. Westpac expects that due to the headwinds described above for 2019, the unemployment rate is likely to rise somewhat through 2019 before drifting back by the end of 2019.

The September quarter Inflation Report printed around the Bank’s expectations and it does not appear to have changed its inflation forecasts.

Since the last board meeting, evidence around house prices and auction clearance rates point to a further slowdown in the Sydney and Melbourne housing markets. Despite that, the Governor’s language around housing is all but unchanged. The slight difference is that he qualifies “credit extended to owner-occupiers” as having “eased” but remaining “robust”, compared to the  October Statement’s description as just “remains robust”.

The second paragraph in the Governor’s Statement which refers to the global economy is identical to the Statement in October, despite developments in equity markets and a surprise reduction in China’s growth rate.

In the following paragraph, which usually relates to financial conditions, the tightening we have seen is noted and equity prices are recognised to have declined. However, there appears to be no real concern about the flow through to the real economy.

We have been a little surprised that the Bank has not recognised the fall in the Australian dollar in recent months referring to it remaining “within the range it has been in the past two years on a trade-weighted basis”. Since the last Board meeting, the TWI actually lifted from 62.2 to 62.3 and yet the Governor has decided to expand on the usual commentary with “although it is currently in the lower part of that range”.

Conclusion

As discussed, we are a little surprised that the Bank has decided to lift its growth forecast in 2019 to 3.5% (0.75% above estimates of potential growth). Westpac expects growth to slow to 2.7% in 2019 (around potential). We will have to wait until the Statement on Monetary Policy on November 9 for an explanation behind this lift.

Clearly, the Bank is less concerned about the headwinds that we have outlined above. As always, while policy is forward looking, it responds to reality rather than long-term forecasts. We expect that through 2019, the Bank will be surprised about the slowdown in the Australian economy and adjust its outlook accordingly. As such, we remain comfortable with our forecast that the cash rate will remain on hold in 2019 and, indeed, in  2020.

BILL EVANS is chief economist of Westpac.