RBA to keep rates on hold: Westpac's Bill Evans

The Reserve Bank Board next meets on August 1.

Of course, the Board will keep rates on hold as clearly signalled by important speeches from both the Governor and Deputy Governor over the last week.

Therefore the interest directly associated with the Board meeting will be with the Governor’s associated Statement.

No doubt the Governor will continue to “call out” the labour market and the housing markets as the key areas of interest. In that regard the sentiment in the July Board Minutes and the Governor’s July Statement is likely to be repeated.

On housing, “Conditions varied considerably across the country. Housing prices have been rising briskly in some markets, although there are some signs that these conditions are starting to ease ....”

On the labour market, the commentary is likely to be along the lines of the Minutes, “Labour market conditions had improved ...forward indicators had remained positive.......The strength of recent labour market data had removed some of the downside risk to the Bank’s forecast of wage growth.”

However on that latter point the Governor’s speech on July 26 indicated that there was limited confidence in the call that wage rates would gradually increase over the course of the forecast period.

And then, of course, there is the Australian dollar. Since the last Board meeting the AUD has increased from USD 0.76 and a TWI of 65 to USD 0.795 and TWI of 67.

Even at USD0.76 the Governor repeated his consistent call that “an appreciating exchange rate would complicate this adjustment.” The language is likely to strengthen at USD 0.795. In his speech on July 21 the Deputy Governor noted: “a lower AUD would be helpful.”

In mid-2015, when the AUD was adjusting, the “path” from USD 0.80 to USD 0.75 was consistently associated with: “Further depreciation is likely/necessary.”

It seems likely that the “commentary” on the AUD in the Governor’s Statement will be stronger than we have seen recently but we cannot be sure that a new “terminology” will be adopted.

Be clear that even though the move in the AUD is associated with higher commodity prices the RBA is uncomfortable. The clear offset to services; manufacturing; and agricultural exports that we might expect from higher commodity prices is not materialising. Cashed up mining companies are not reinvesting and are not lifting employment in this cycle largely because they are not convinced of the sustainability of the current increases. As such the higher AUD is a “challenge” for both growth and inflation.

In that regard the second RBA report for the week will be more significant. The Statement on Monetary Policy will be released on August 4 and will contain the Bank’s revised growth and inflation forecasts.

These forecasts will be provided out to end calendar 2019, extending from June 2019 currently.

Recall the convention for the assumptions behind the forecasts. The rate profile is that indicated by market pricing and the AUD profile assumes the current level of the AUD.

When the last forecasts were released in May the rate outlook was flat while the AUD was at USD 0.74 and TWI 64.

Today markets are pricing in a 0.25% rate hike by the second half of 2018 while the AUD is likely to be assessed at USD0.80 or TWI 67.

The issue is whether the Bank will change its forecasts on the basis of the new “assumptions”.

The key forecasts from a policy perspective are GDP growth in 2018 and underlying inflation in 2018 and 2019.

In May, GDP growth in December 2018 was forecast at 2.75%-3.75% and underlying inflation at 1.5-2.5% in 2018 and 2-3% in June 2019.

We are not aware of the Bank’s specific modelling methodology and of course any potential “subjective” adjustments that might be applied to the modelling before the final results are released.

However we can assess some historical “form”.

In November 2016, when AUD was at USD 0.77 and the TWI at 65, growth in 2018 was forecast at 3-4% and underlying inflation at 1.5- 2.5%.

In May 2017, when AUD was at USD 0.74 and the TWI at 64, growth in 2018 was forecast at 2.75%-3.75% and underlying inflation at 1.5- 2.5%.

You can see that between November and May there was a US 3 cents move in the AUD yet no significant changes were made in the forecasts. In fact a lower AUD was associated with a modest downward revision in the growth rate.

Elsewhere, the positive global back drop, with upgrades to world growth, and domestically the surprisingly strong employment figures, buoyant business confidence surveys and expansionary public investment would have boosted the Bank’s confidence in their above trend growth forecast for 2018 (with trend growth estimated at 2.75%). Those developments would support the Bank’s inclinations to keep their growth forecasts intact.

For 2019, consistent with the above, the RBA is likely to restate their 3.25% growth forecast for June 2019 and to also forecast 3.25% for December 2019, which rolls into the forecast horizon.

Certainly there seems little chance that the Bank would react to the AUD developments by lowering its underlying inflation forecast for 2018 which already sits at the bottom of the 2-3% target band.

No doubt there will be considerable angst at the Bank around the growth forecast.

For me, rigid adherence to the assumption of an AUD holding
at USD0.80 over the next 3 years with a resulting change to the confident “above trend” growth story in 2018 would be an unattractive option for the Bank.

Consequently, despite the sharp short term move in the AUD, I expect the RBA to retain its “above trend” growth forecast when it releases its forecasts in the Statement on Monetary Policy on August 4. 

BILL EVANS is chief economist of Westpac.