Infrastructure boom fundamental in driving the economy: CommSec's Craig James

EXPERT OBSERVER

Three months ago we said “It all gets down to jobs.” And that point has clearly been emphasised by the Reserve Bank in the period since. If the Reserve Bank is tempted to cut interest rates in coming months it will be because there is clear evidence that the jobless rate is trending higher, while at the same time there is disappointment on the wages paid by employers.

You have to admire the Reserve Bank’s stoicism with its forecasts. Over the past six months the Reserve Bank has downgraded short-term economic growth and inflation forecasts and pushed-out its expectations by around a year.

Confusingly Reserve Bank “domestic forecasts are conditioned on the technical assumption that the cash rate moves in line with market pricing, which implies two 25 basis point cuts to the cash rate.” Despite that, inflation struggles to get to 2 per cent and the jobless rate stays at 5 per cent. The Reserve Bank needs to provide a clearer explanation of his views and assumptions.

Reserve Bank remains confident on outlook:

The full Statement on Monetary Policy can be found here: https://www.rba.gov.au/publications/smp/2019/may/pdf/statement-on-monetary-policy-2019-05.pdf

• Key Paragraph: “At its recent meeting, the Board focused on the implications of the low inflation outcomes for the economic outlook. It concluded that the ongoing subdued rate of inflation suggests that a lower rate of unemployment is achievable while also having inflation consistent with the target. Given this assessment, the Board will be paying close attention to developments in the labour market at its upcoming meetings.”
• Growth & inflation: “Growth in the Australian economy has slowed and inflation remains low.”
• Spending: "The near-term outlook for consumption growth has been revised lower because weaker housing market conditions and income growth are likely to continue to drag on spending."
• Household spending: “Subdued growth in household income and the adjustment in the housing market are affecting consumer spending and residential construction. Despite this, the labour market is performing reasonably well, with the unemployment rate steady.”
• Incomes: "Some recovery in income growth is likely, because employment growth is expected to remain solid, wages are expected to increase and the tax offset for low and middle-income taxpayers is set to come into effect in the second half of this year."
• Incomes: “Disposable income growth is also expected to be supported by lower net interest payable owing to the lower cash rate assumption.”
• Home prices & spending: "The deterioration in housing market conditions is expected to continue to weigh on consumption in coming quarters."
• Home building: "There is a risk that dwelling investment declines by more than currently forecast in the near term."
• Home building: …“information from the liaison program points to a significant slowdown in activity in the early stages of residential development.”
• Inflation: Core inflation is “expected to remain low in coming quarters, largely because the weakness in housing- related items is expected to persist for a while.”
• Global: “The global growth outlook has been revised slightly lower and the risks remain tilted to the downside.”
• China: “The outlook for China continues to be an important source of uncertainty for the external environment facing Australia’s economy. The Chinese authorities face significant policy trade-offs and it is unclear how various policy changes will play out.”  “The outlook for trade policy remains uncertain and negative developments could harm global growth.”
• Wage pressure: “…there has been some upward pressure on inflation as a result of the decline in labour market spare capacity.”
• Wages: “The moderate increase in wages growth forecast over the next year is consistent with information from the Bank’s liaison program.”
• Jobs: “A number of other indicators suggest that labour market conditions remain positive and that spare capacity is being absorbed. There has been a notable decline in the rate of medium-term unemployment (between 13 weeks and one year)…”

Implications for interest rates and investors:

CommSec doesn’t expect a change in interest rates for a few months yet. But a cut in rates is factored into Reserve Bank forecasts, presumably on a softer job market.

The Reserve Bank says that “The domestic forecasts are conditioned on the technical assumption that the cash rate moves in line with market pricing, which implies two 25 basis point cuts to the cash rate.” While the RBA always notes that forecasts are based on technical assumptions, this time it is quite explicit with the rate cut assumptions.

The Reserve Bank is no doubt hoping that fiscal stimulus is applied over the next year through tax cuts and targeted spending. The 

Craig James is the chief economist at CommSec.