RBA more positive on the Australian economy: Westpac's Bill Evans

GUEST OBSERVER

The minutes of the monetary policy meeting of the Reserve Bank Board were a little more upbeat on the economy than we saw in November. 

In the key section of the minutes ‘Considerations for Monetary Policy’, the Board noted that “recent data had generally been positive”. That compared with the November minutes which noted that “recent data … suggested that the moderate economic expansion had continued”. 

We also saw a more upbeat analysis of the labour market. In December the Board notes that very low interest rates and the lower currency were leading to “stronger employment growth”. In November this recognition of an improving labour market was restricted to the services sector. 

It should be noted that this more optimistic assessment was reached without the benefit of knowing the stronger than expected GDP report (released the day following the meeting) and the November employment report which showed a fall in the unemployment rate to 5.9%. 

Of course despite this more optimistic tone there was no change to the soft easing bias which was signalled using the same language as in November: “Members judged that the outlook for inflation may afford some scope for a further easing of monetary policy”. That approach continues to be justified by members recognising that there was still evidence of spare capacity in the economy including in the labour market and that wages growth remained low with inflation expected to be consistent with the target. 

Commentary on the Australian dollar was unchanged from November: “the exchange rate was adjusting to the significant declines in key commodity prices”. We are not surprised by this sentiment given that the Governor’s statement used the same approach. However as we noted in commenting on the Governor’s statement this approach could have justifiably been strengthened given that since the November meeting the AUD had increased from US0.715 to US0.725 and the iron ore price had fallen around 15%. There was a case for the Bank to question whether the AUD should have been adjusting to the recent weakness. No doubt the Bank will be monitoring this situation and if it continues it is likely to strengthen its language in the February minutes. 

There was indeed indirect recognition of this point. In November the minutes noted “Members noted that the outlook for Australia’s terms of trade was little changed”. There is no such recognition in the December minutes leaving open the possibility that reflecting this recent weakness in both iron ore and oil prices the Bank may now be further revising down its growth forecasts for the terms of trade. Westpac has certainly done that with our outlook for 2016 indicating a further fall of 10%, with implications for both household expenditure and business investment. It is likely that these adjustments will now be considered for the forecasts in the February Statement on Monetary Policy. 

Outlook

The Board clearly intended these minutes to signal no change in the policy stance. That is consistent with our own view for 2016. However, given the recent weakness in the terms of trade, risks to our view remain to the downside.

Bill Evans is chief economist of Westpac.