From the happy warrior:
Australia’s rebalancing act is underway; low interest rates are already working and the lower AUD should lift growth
- At the same time, inflation is low, which leaves the RBA with scope to consider rate cuts, although the trade-off is the risk of over-inflating an already booming housing market
- We still see the RBA holding rates steady next week, but given recent cuts by other global central banks, it is a close call, and a rate cut is certainly a possibility
To cut or not to cut, that is the question
Whether the cash rate will be cut again or not is being hotly debated by RBA observers, particularly with the market pricing in 11bp of cuts next week and given the recent Bank of Canada cut. As is often the case, there are good arguments on both sides of the debate.Indeed, the monetary policy outlook is particularly complicated this year, as Australia faces large forces working in opposite directions. On the downside, activity in the mining sector is slowing substantially. A fall in iron ore and coal prices has been a drag on national income and resources sector investment is also declining, following a substantial ramp-up in previous years.
On the upside, there are signs that growth is still rebalancing. The RBA’s already ‘very’ low cash rate is still lifting housing prices (8% y-o-y), building approvals (11% y-o-y), retail sales (5% y-o-y) and credit (6% y-o-y).
While business confidence is on the weaker side, business conditions have trended higher, and there are signs that the labour market is improving. Resources exports are also ramping up as new capacity comes online, with a large boost yet to come from new LNG exports this year and beyond. We see the recent fall in the AUD and oil prices as helping this story, as they should both support demand.
Ultimately, the RBA usually sums up these forces by tracking and forecasting underlying inflation. The recent upside surprise to the Q4 2014 underlying inflation measures (0.7% q-o-q; market had 0.5%) should tell the RBA that demand has been holding up fairly well.
At the same time though, the recent fall in oil prices is likely to deliver even lower inflation in future, which could leave the RBA with scope to consider cutting rates.
In deciding whether to cut further, the RBA also needs to weigh the benefits of lower rates against the potential costs of over-inflating the housing market. We think this trade-off will see the RBA sit still with its 2.50% cash rate, rather than cut, but it is close.
Roll over, matey!
