Bill Evans
RBA keeps rates on hold, commentary slightly more upbeat than in December.
3:32PM, 07 Feb 2017
As expected the Reserve Bank Board decided to hold the overnight cash rate unchanged at 1.5%.
The commentary in the Governor’s statement was a little more upbeat than had been the case in December. In particular the global view has been lifted from global growth “lower than average” to “growth above trend in a number of developed economies.”
Another aspect of the importance of global growth has been the ongoing strength in commodity prices. This statement notes that the terms of trade have risen and this will boost national incomes.
The Bank confirms its forecast in November that growth in 2017 and 2018 will be around 3%. In fact the 2018 forecast is 3.5% and given the more recent official forecasts we saw from the Government in the December Mid Year Economic and Fiscal Outlook that 2018 number is likely to be shaved a little to 3.25%. Nevertheless 3% is considered to be above the Bank’s assessment of trend (2.75%) and therefore implies a gradually strengthening labour market.
The statement directly addresses the reported contraction in the economy in the September quarter attributing it to “temporary factors” with the RBA expecting a return to reasonable growth in the December quarter. In that regard while consumption is expected to remain moderate, non mining investment is anticipated to show “some pick up”.
Specific commentary on the labour market is largely unchanged with conditions described as mixed although the Bank notes that leading indicators are pointing to continued expansion.
Commentary on the housing market is also largely in line with the December statement with the market described as strengthening overall and prices rising briskly in some cities. In fact in December the statement pointed out that turnover had been lower and this comment is absent in this statement. There is also some emphasis on the tightening in lending conditions from the banks that will give the RBA some comfort with respect to any financial stability risks.
Commentary around inflation remains confident pointing out that the most recent inflation report was in line with expectations and both headline and underlying inflation were expected to rise above 2% over the Bank’s forecast period.
Conclusion
This statement clearly sets out the Bank’s current policy approach. That is, to hold rates steady in anticipation of a gradual lift in growth and inflation while imbalances in the housing market remain contained. We expect this thinking will be sustained throughout 2017 being supported by a rising terms of trade, a peaking construction cycle and a gradually falling unemployment rate with rates remaining on hold. Our central view for 2018 would be a similar policy stance despite clear preferences in the market for the beginning of a tightening cycle. Westpac’s view on growth in 2018 is that is it will slow down to a below trend 2.5% with housing construction contracting, the terms of trade falling, and ongoing moderation in consumer spending and business investment. This pitches the risks to the “on hold” call in 2018 to the downside in clear contrast to current market views.
CBA
| The decision: On hold and neutral bias reaffirmed.
The RBA’s decision to leave the cash rate unchanged today came as no surprise. Market pricing had implied very little chance of policy easing in February despite inflation continuing to run below target. Concerns around the further build‑up of debt in the household sector and strong dwelling price growth have reduced the odds of another rate cut despite inflation remaining below the target band. In addition, domestic income is receiving a boost from firmer commodity prices. The Governor’s Statement today was the first commentary out of the RBA on the economy since mid‑December. And it was the first opportunity the Bank has had to opine on the QIII GDP shocker (0.5% contraction). The Governor appears unperturbed by the fall, noting that growth was weaker than expected because of “temporary factors.” And, “a return to reasonable growth is expected in the December quarter.” The Governor sounds relatively upbeat on the domestic economy in general. The RBA’s central forecast is for, “economic growth to be around 3 per cent over the next couple of years.” In addition, Lowe suggested that, “some further pick‑up in non‑mining business investment is also expected.” In our view, that’s a bullish statement given we are yet to observe a meaningful lift in private non‑mining investment. The last RBA comment on the capex outlook was “subdued.” So today’s comment is a significant upgrade to what has been a weak part of the economy story. The Governor sounds sanguine on the labour market. Lowe pointed out that although the unemployment rate has recently moved a little higher, full time jobs, “turned positive in late 2016.” He also noted that, “the forward‑looking indicators point to continued expansion in employment.” We agree and point out yesterday’s solid 4.0% rise in job ads over January as evidence. On inflation, the Governor expects headline inflation to return to within the target band in 2017. But the lift in underlying inflation is expected to be, “a bit more gradual.” The Governor stuck to the recent script on the housing market, noting that, “in some markets (i.e. Sydney and Melbourne), conditions have strengthened further and prices are rising briskly. In other markets, prices are declining.” He added that there has been stronger demand by investors. This is consistent with the lending data. The outlook The RBA has left policy on hold since August 2016 despite the last two quarterly inflation reads printing below target. Put another way, the RBA has not cut rates since Dr Lowe become Governor despite core inflation continuing to run sub‑2.0%. Therefore we conclude that the RBA, under new Governor Lowe, is willing to |
| tolerate inflation below the target band if it reduced the risk of financial imbalances and the further build of up debt in the household sector. Dr Lowe, in his capacity as Governor, has made remarks around this on more than one occasion.
We think that the RBA faces a tough job in returning inflation to target. And we don’t expect core inflation to get back to within the target band until 2018. But in our view, the hurdle for another rate cut is higher than it was last year. With the Fed tightening further in 2017, firmer commodity prices, public infrastructure spending lifting and continued strength in the housing market, we see the RBA content to leave rates on hold despite inflation undershooting the target. The risk, however, sits with easing over the next six months because we don’t see enough strength in the labour market to push inflation materially higher. Any loss of momentum in the labour market, coupled with some cooling in the housing market, could see policy easing come back on the table. Market attention now quickly turns to Thursday night when the Governor will deliver a speech at an economic forum dinner. And on Friday the RBA will publish its February Statement on Monetary Policy (SMP). In our view, the RBA is likely to downgrade its near term growth forecasts. But the bigger picture through the RBA’s lens is unlikely to be changed. The RBA is expected to leave its inflation forecasts unchanged. And they will also extend their forecast horizon to June 2019. The expected downward adjustment to the Bank’s near term growth profile supports market pricing that the risk lies with another cut over the next six months. |
Deutsche Bank
AUSTRALIA VIEW: Deutsche Bank economists says the RBA’s policy stance remains neutral in today’s statement but they continue to look for a cut this year. “This is primarily because we see few reasons why core inflation in Australia will lift in coming quarters given the AUD TWI (trade-weighted index) is higher than a year ago and also given that wages growth continues to either make new lows or run near record low levels,” they wrote in a note. They maintain the risk around their May timing for a cut is that it ‘slips’ into August.
Citigroup
AUSTRALIA VIEW: Citigroup economists think the RBA’s views in the cash rate statement on recent activity data is more positive than them. Their own view is that headwinds such as slower building approvals and retail sales growth point to ongoing sub-trend spending growth more broadly. They also point to RBA noting that full-time employment turned more positive late in 2016 but they are highlighting the recent increase in labour force participation that has added spare capacity to the labour market and which risks lifting the unemployment rate and keeping wages growth subdued for longer. Citi economists think the earliest timing for “live” RBA meeting won’t be until May, and while their central case remains for no change in cash rate this year, they also retain view that market is under-pricing risk of easing.