By BOQ Chief Economist, Peter Munckton.
- The RBA again kept the cash rate at 1.5%;
- If the RBA forecasts prove to be correct then the next move is up;
- But it will also mean that the next move is still some way into the distance;
- At this stage any cash rate change is a forecast not a promise.
‘Doctor, Doctor, gimme the news’’
Robert Palmer, Bad Case of Loving You
Robert Palmer was a well-known English singer who was particularly big in the 1970’s and 1980’s. He was probably best known for ‘Simply Irresistible’, although others would argue for ‘Addicted to Love’. He had 19 top 100 hits in Australia alone. ‘Bad Case of Loving You’ did well, reaching the top 20 in a number of countries and number one in Canada.
I am not sure how closely Robert Palmer followed economics but every month financial markets eagerly wait on the news from RBA Governor, Dr Phil Lowe. The headline grabber of course is if there is a change in the cash rate. Following the November meeting it is 27 months and counting since the RBA last reached for the interest rate lever. Without an attention-grabbing headline, analysts spend their time poking through the regular statements to see if there are any interesting tidbits. Below is the recent statement for the November Monetary Policy meeting, together with a few thoughts on each of the areas.
RBA comment: “The global economic expansion is continuing. A number of advanced economies are growing at an above-trend rate and unemployment rates are low. Growth in China has slowed a little, with the authorities easing policy while continuing to pay close attention to the risks in the financial sector. Globally, inflation remains low, although it has increased due to both higher oil prices and some lift in wages growth. A further pick-up in inflation is expected given the tight labour markets and, in the United States, the sizeable fiscal stimulus. One ongoing uncertainty regarding the global outlook stems from the direction of international trade policy in the United States.
BoQ comment: “In recent times there has been some concern as to whether the global economy is slowing. This does not seem to be worrying the RBA (or judging by their recent statements, other central banks). Not only is the unemployment rate low in many countries, it has fallen in many of them over the past year. Everyone is watching China, struggling against a garden-variety economic slowing and high debt levels. The Chinese Government is putting its shoulder to the economic wheel by easing fiscal policy and reducing interest rates. History suggests that they will be successful, although the rate of debt increase over recent years raises the risks. It was interesting that the RBA did not mention Emerging Markets. While things have settled down in recent weeks, they were the talk of the town only a month ago. Emerging markets remain vulnerable if global interest rates continue to rise. The tariff battle has moved on from being a mere risk to one having an impact on global trade and business confidence. To date that impact has been minimal. But the longer the battle lasts, the bigger the problem.”
RBA comment: “Financial conditions in the advanced economies remain expansionary but have tightened somewhat recently. Equity prices have declined and yields on government bonds in some economies have increased, although they remain low. There has also been a broad-based appreciation of the US dollar this year. In Australia, money-market interest rates have declined recently, after increasing earlier in the year. Standard variable mortgage rates are a little higher than a few months ago and the rates charged to new borrowers for housing are generally lower than for outstanding loans.
BoQ comment: “The RBA appears sanguine about financial market developments despite the recent significant increase of volatility. Rising interest rates has been the catalyst. But high valuations (particularly the US equity market) has been the underlying issue. Other equity markets have also been hit despite having more reasonable valuations. The recent bout of financial market volatility came after a period when it was unusually low. So perhaps it could be better described as a return to more ‘normal’ levels. In an event, volatility in the foreign exchange and bond markets did not rise to the same extent. Overall, recent development in financial markets and their impact on domestic interest rates does not appear to be a major factor in current RBA thinking.
RBA comment: “The Australian economy is performing well. Over the past year, GDP increased by 3.4 per cent and the unemployment rate declined to 5 per cent, the lowest in six years. The forecasts for economic growth in 2018 and 2019 have been revised up a little. The central scenario is for GDP growth to average around 3½ per cent over these two years, before slowing in 2020 due to slower growth in exports of resources. Business conditions are positive and non-mining business investment is expected to increase. Higher levels of public infrastructure investment are also supporting the economy, as is growth in resource exports. One continuing source of uncertainty is the outlook for household consumption. Growth in household income remains low, debt levels are high and some asset prices have declined. The drought has led to difficult conditions in parts of the farm sector.
BoQ comment: “The momentum in the economy has been better than what the RBA (and most forecasters) have predicted for 2018. The result is that the RBA has revised up their growth forecasts for both this year and next, and revised down their unemployment rate prediction. As noted wages growth is the key domestic economic variable to watch over the next 1-2 years. Higher wages growth will mean that consumers can spend more and more easily pay down debt. Higher wages will also make it more likely that inflation will sustainably increase to a rate beginning with a 2. The RBA noted that economic growth will be slower in 2020 reflecting weaker growth of exports. But there was no mention that there will also be less residential building activity in that year. The key question for the domestic economy in 2020 will be whether stronger consumer spending can offset weaker export and residential spending. The decline in some asset prices is likely a reference to the fall in house prices (and equity markets). A number of analysts are concerned that this could mean slower consumer spending. But there is substantial disagreement as to how big an impact falling house and equity prices has on consumer spending at a time when employment is increasing.”
Australian dollar/commodity prices
RBA comment: “Australia's terms of trade have increased over the past couple of years and have been stronger than earlier expected. This has helped boost national income. While the terms of trade are expected to decline over time, they are likely to stay at a relatively high level. The Australian dollar remains within the range that it has been in over the past two years on a trade-weighted basis, although it is currently in the lower part of that range.
BoQ comment: “Australia has benefitted from stronger than expected commodity prices. The $A has weakened against the $US, although that has been the fate of most currencies this year. When measured against the currencies of all major trading partners, the $A is only a touch below its long-term average. The interest rate outlook is a negative for the $A. But the currency is being supported by better than expected commodity prices and a relatively narrow current account deficit.”
RBA comment: “The outlook for the labour market remains positive. With the economy growing above trend, a further reduction in the unemployment rate is expected to around 4¾ per cent in 2020. The vacancy rate is high and there are reports of skills shortages in some areas. Wages growth remains low, although it has picked up a little. The improvement in the economy should see some further lift in wages growth over time, although this is still expected to be a gradual process.
BoQ comment: “Wages growth is only a little ahead of prices growth, and this is limiting the number of consumer journeys to the shop (either physically or online). All the signs are that there still should be plenty of jobs created over the next 6 months. Thereafter the performance of the jobs market will come down to the strength of the economy. The RBA expects a modest rise of wages over the next year. And this looks likely given the current strength of the labour market. But a more substantial rise in wages will take higher productivity growth (so firms can afford to pay more) and/or higher inflation expectations (so firms can pass on higher costs). An unemployment rate forecast of 4.75% appears modest given the RBA’s expected growth of GDP (part of the answer is that there is likely to be some decline in the underemployment rate – those working part-time that want a full-time job).”
RBA comment: “Inflation remains low and stable. Over the past year, CPI inflation was 1.9 per cent and, in underlying terms, inflation was 1¾ per cent. These outcomes were in line with the Bank's expectations and were influenced by declines in some administered prices due to changes in government policies. Inflation is expected to pick up over the next couple of years, with the pick-up likely to be gradual. The central scenario is for inflation to be 2¼ per cent in 2019 and a bit higher in the following year.
BoQ comment: “Inflation has been subdued over the past six months. And the proportion of items growing by under 2% is relatively high, and over 3% relatively low. But the RBA appears comfortable that inflation will increase to within its target band next year. A lower exchange rate and higher petrol prices will add to the CPI in the near term. So will higher global inflation. Higher wages growth will be the key to the RBA achieving its inflation forecasts. An inflation forecast of above 2.25% for 2020 (if achieved) would be consistent with a higher interest rate.”
RBA comment: “Conditions in the Sydney and Melbourne housing markets have continued to ease and nationwide measures of rent inflation remain low. Growth in credit extended to owner-occupiers has eased but remains robust, while demand by investors has slowed noticeably as the dynamics of the housing market have changed. Credit conditions are tighter than they have been for some time, although mortgage rates remain low and there is strong competition for borrowers of high credit quality.
BoQ comment: There has been a lot of attention focussed on the decline in house prices, although the RBA commentary is sanguine. The big increase in supply of housing has played an important role in the slowing in house prices, and possibly is what the RBA means by the changing housing market dynamics. Credit growth is modest by historical standards. But the RBA has (rightly) noted that much of the slowing in credit growth has been by investors (partly driven by the fall of house prices). The RBA notes the tighter credit conditions, although this is less a concern for good quality borrowers. And lending outside of the banking sector is picking up. Overall, the changes in the housing market have not significantly changed the RBA’s view of how the economy is evolving.
RBA comment: “The low level of interest rates is continuing to support the Australian economy. Further progress in reducing unemployment and having inflation return to target is expected, although this progress is likely to be gradual. Taking account of the available information, the Board judged that holding the stance of monetary policy unchanged at this meeting would be consistent with sustainable growth in the economy and achieving the inflation target over time.
BoQ comment: “On their current forecasts the RBA thinks the next move in the cash rate will be up but not for some time. Of course this is a forecast, not a promise. A weak China, problems in Europe, low wages growth, declining house prices and high household debt are all risks. The central view of the RBA is broadly consistent with both current financial market pricing and the weighted average of economist expectations.”
Overall, the latest news update from Dr Lowe is good. The economy is doing well, the unemployment rate is expected to fall further. At some stage this could mean higher interest rates. But not for some time. Others disagree, thinking the evident risks will lead to less rosy times. Only time will tell. Either way (for an economist at least) the (economic) news will be simply irresistible.
We live in interesting times.