Possible lowering of RBA's inflation forecasts: Westpac's Matthew Hassan

GUEST OBSERVER

The minutes of the April monetary policy meeting of the Board of the RBA provided few surprises but some notable choices in wording and some elaboration on key themes in the Governor’s decision statement.

Recall that the minutes relate to a meeting on April 5 and pre-date more positive monthly data on jobs and surveyed business conditions but also a drop in consumer sentiment and a further rise in the AUD.

Our main points of interest are the discussion in the ‘Considerations for policy’ section and the additional detail on assessments of current conditions and prospects.

The minutes repeat the main points from the Governor’s decision statement, including the key line that “Continued low inflation would provide scope for easier policy, should that be appropriate to lend support to demand”, a more upbeat assessment on the economy following the December quarter national accounts, commentary on the AUD that was more ‘factual’ than ‘critical’, and reduced concern about the potential impact of “financial turbulence” which was a more prominent issue in March.

The key new takeaways from the minutes are:

• a clear assessment that the more positive tone on domestic activity was carrying into 2016;
• slightly more stress being placed on the current degree of policy stimulus;
• a bolstering of expectations that inflation will remain low;
• and the critical channel of concern for the AUD rise being the impact on the services export sector. 

Taking each of these point in turn:

The Governor’s statement had relatively little to say on Australian economic activity other than that the economy was continuing to rebalance and there were reasonable prospects for continued growth. The minutes flesh this out much more with key comments elevated to the ‘considerations’ section.

The key line here is: “Domestically, the latest national accounts data suggested that the economy grew at a moderate pace in the December quarter and more recent data were consistent with this having continued in early 2016.” That compares to the comment in the March meeting minutes that “available data suggested that the domestic economy had continued to grow at a slightly below-trend pace”. It is somewhat interesting that the April minutes do not mention growth in relation to trend (on most measures it would be best described as near trend). However, the main point is really that this momentum is seen as having carried into 2016, a view that would have been reinforced by the March labour force survey and March business survey results.

The ‘considerations’ section included a notable tweak in wording on current policy settings, assessed as “very accommodative” rather than merely “accommodative” in the Governor’s statement. Although the meaning of this shift is open to interpretation, we would view putting more emphasis on the degree of stimulus as a subtle way of saying that the ‘hurdle’ for additional stimulus measures is higher. The shift in wording seems a little odd given the degree of attention paid to the wording in the Governor’s statement.

On inflation, the ‘considerations’ section emphasises the downside: “On all measures, wage growth remained at quite low levels and domestic cost pressures, more generally, remained subdued. Combined with the appreciation of the exchange rate and the low level of inflation globally, this suggested that inflation in Australia was likely to remain low over the next year or two.” This compares to the same section in the March minutes which simply noted “Wage growth had remained at quite low levels”. The commentary is pointing towards a likely lowering in the RBA’s inflation forecasts, something we have flagged as a possibility.

On the AUD, the key minutes repeated the concern that “an appreciating exchange rate could complicate progress in activity rebalancing towards non-mining sectors”. Two other comments provide an important elaboration on this: “Members noted that the recent rebound in commodity prices, even if sustained, was unlikely to lead to any material change in mining investment over the next couple of years”; and “Members observed that [the net services exports] component of GDP was one of the most sensitive to changes in the exchange rate and discussed the impact of exchange rate movements on the economy more broadly.”

That suggests the key complicating factor from an AUD rise is that the degree of stimulus from an associated rise in the terms of trade for the mining sector may be limited and that the main source of weakness could be around services exports. That in turn suggests activity measures in the latter – confidence, conditions, employment – will be the critical test for whether the rise is becoming a factor (i.e. “could complicate” becoming “is complicating”). Clearly the RBA is greatly interested in the sectoral make-up of activity indicators in coming months.

Aside from these main points, the minutes seemed a little more positive on international conditions – China in particular where the pace of overall growth was described as having been broadly unchanged in the first two months of 2016 vs referring to “continued weakness in the industrial and real estate sectors” back in March – and financial markets which had improved, but were wary of the rally in Australia’s commodity prices.

Conclusion

The minutes provide some valuable insight into the Bank’s assessment of conditions domestically and the nature of the risks it is assessing, particularly around the recent gains in the AUD. Both continue to suggest the Bank is comfortable with current policy settings and although there are clearly risks around the outlook, particularly vis a vis the AUD, we are comfortable to retain our call that rates will remain on hold for the remainder of 2016, with the proviso that we do not envisage a further significant surge in the AUD.

We continue to see the Bank’s strategy on the AUD as hinging on whether 'new' levels of the currency are sufficient to markedly change its forecasts for inflation and, much more importantly, growth. The RBA will provide updated forecasts in its May Statement on Monetary Policy (due May 6).

On growth we expect the stronger than expected Q4 national accounts to offset downward revisions from a higher currency, holding the RBA’s forecast steady at 3% – at most growth may be revised down 0.25ppts but even this would leave its 2016 forecast at ‘trend’. On inflation, the March quarter CPI (due April 27) is key input – our expectation of a 0.6 percent/qtr gain in the core CPI measure is also likely to limit any downgrade to the Bank’s forecasts with its 2016 view on underlying inflation likely to be pared back 0.25ppts to a range mid-point of 2.25 percent for 2016. Neither of these adjustments look like being substantive enough to trigger a policy response.

Matthew Hassan is senior economist with Westpac.