Reserve Bank minutes highlight uncertainty about housing and labour markets: Westpac's Bill Evans

Reserve Bank minutes highlight uncertainty about housing and labour markets: Westpac's Bill Evans
Reserve Bank minutes highlight uncertainty about housing and labour markets: Westpac's Bill Evans

GUEST OBSERVER

The minutes of the monetary policy meeting of the Reserve Bank Board for October, which mark the first meeting of the new Governor Lowe, provide significant insight into the Board’s current deliberations.

The minutes are quite honest that there is a high degree of uncertainty in a number of areas. In particular the assessment of the labour market is quite mixed and conflicting evidence is presented around the housing market.

The minutes point out that even though the unemployment rate has fallen by half a percentage point over the past year the underemployment rate, which captures workers who would like to work more hours, has increased. That message is consistent with a number of other developed economies where the unemployment rate is not necessarily a clear indicator of spare capacity in the labour market. In a speech which the Governor delivered today he estimates that the current unemployment rate is around half a percent above ‘full employment’, pointing to ample spare capacity in the labour market. However, the minutes do note that job vacancies and advertisements have increased and are consistent with employment growth in the coming months. There is also a more confident assessment that the relentless downward pressure on earnings may be waning. Recent evidence from the national accounts shows that average earnings have picked up in the past two quarters because the switch from high paying mining-related jobs to lower paying service jobs has slowed. The increase in the terms of trade in the June quarter, and expected increase for the September quarter also point to a boost to wages and profits.

The assessment of the housing market is more uncertain than had been the case at the time of the August rate cut. In particular for the first time in this cycle the Board recognises high auction clearance rates in Sydney and Melbourne and strengthening house price growth. Uncertainty around the outlook for housing is most clearly emphasised when the minutes states: “developments  would need to be monitored closely”.

In the speech referred to earlier the Governor linked those two markets back to monetary policy’s key objective around inflation. He pointed out that the need to achieve the inflation target should be affected by the conditions in labour and housing markets. For example, if inflation was well below the target but moving it back to the target came at the cost of a weakening of balance sheets and an unsustainable build up in leverage, a longer period away from the target would be appropriate. On the other hand if the labour market was deteriorating then a much more rapid movement towards the target would be appropriate. Clearly the story is never as clear cut as that but we can see strands of that approach to policy coming out in the minutes where uncertainty around those two markets is a central theme., although the assessments of the Sydney and Melbourne housing markets counsel caution.

The minutes also surprised us by the explicit sentence in the final paragraph: “Members noted that data on CPI inflation for the September quarter and an update of the forecasts would be available at the next meeting”….. providing the opportunity to review conditions in the labour and housing markets. Explicitly recognising the upcoming inflation report is not a standard approach. Certainly,it was referred to explicitly in the July minutes when we were clearly conditioned to see the June quarter inflation report as critical to the August policy decision.

We have not been of the view that the next inflation report will have the same significance. Bear in mind a 0.3%qtr is dropping out of the annual number and so the report would have to indicate that core inflation printed 0.2%qtr or less to see a further fall in annual inflation. We think that is extremely unlikely given our own forecast of 0.4%qtr and therefore an actual increase in annual underlying inflation from 1.5%yr to 1.6%yr. It is reasonable to assume that the Bank has a similar number in mind and therefore eliminating any case for a  policy response. However, choosing to include this sentence in the minutes and noting that the Governor has used the same observation in his speech today points out that given the uncertainty around housing and labour markets there may be a sufficiently low number that would put policy back into play for November. That is not to say that there would be an automatic policy response to an extraordinarily low number given that further information will also be available on the housing and labour markets.

While the minutes do not consider inflation expectations the Governor’s speech today highlights their importance- in particular the significance of the current inflation read for impacting inflation expectations: “One of the key influences on inflation expectations is the actual outcomes for inflation” – this observation further emphasises his assessment of the importance of current inflation for the future path of inflation.

There were no other surprises in the minutes. The Board is slightly more positive about the global economy as a result of a better performance from China. The minutes point out the recent boost to commodity prices but recognise that supply effects have been critical to this adjustment. It is our view that with evidence that supply is already responding, particularly in China, prices will adjust back towards costs of production over the course of the next year.

While the minutes included a section on the Bank’s half yearly assessment of the financial system (Financial Stability Review) there was surprisingly little emphasis on the risks around the inner city apartment market. Consistent with the Bank’s uncertainty around the residential property market the minutes are surprisingly brief on this issue.  

Conclusion

The minutes and today’s speech have provided us with valuable insights into the core approach to policy that we can expect from the new Governor. Less emphasis on specific inflation targeting and direct consideration of the implications of policy for housing and labour markets is clearly spelled out. However, the minutes do remind us that inflation is still the central policy objective and the inflation reports which we receive on a quarterly basis will always be important to the policy response. Based on the Governor’s apparent uncertainty around housing and the labour market at the moment it is clear that he would not welcome a sharp negative surprise on current inflation. We do not think that such an outcome is at all likely and we also believe that his tolerance for a very low number will be high but not infinite.

We maintain our long held view that rates will remain on hold in November and developments in the real economy will be sufficiently supportive to keep rates on hold in 2017.

BILL EVANS is chief economist of Westpac.

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