From Bill Evans:
The Reserve Bank’s February 2016 Statement on Monetary Policy provided few surprises.
The key growth and inflation forecasts for 2016 have remained the same as the November Statement. For 2017, there has been a modest reduction in forecast growth from 3.00-4.00%yr to 2.50-3.50%yr. The underlying inflation forecast of 2-3%yr is unchanged. The Bank has extended its forecast to June 2018, when it expects growth to lift to 3-4%yr. In effect, the lift in growth from 3.0%yr to 3.5%yr has been pushed back by six months.
Reflecting the stronger than expected GDP report in the September quarter, forecast growth to December 2015 has been increased from 2.25%yr to 2.50%yr, but that still implies GDP growth in the December quarter will be around 0.5-0.6%.
We are not at all surprised that the growth profile remains broadly unchanged, and the inflation forecasts accord with the views we expressed in the preview to this Statement on January 29. When we saw the Governors Statement and he referred to “low inflation” over the next 1-2 years rather than “in the target band”, there was a case to expect that the RBA might have revised down its underlying inflation forecast to 2.00-2.50%. That would have been consistent with ongoing prints of 0.5% per quarter, but these forecasts indicate the Bank expects average prints of 0.6%. Indeed, the commentary confirms the view that the lagged pass-through of the fall in the Australian dollar will add around 0.5% to underlying inflation in both 2016 and 2017. As we pointed out at the time of the release of the December quarter inflation report, there was some evidence in both clothing and domestic holidays that this pass-through was underway.
The assumptions behind the forecasts assume a lower terms of trade by 4% and a 30% fall in the oil price from US$52 per barrel in the November Statement to $US35 currently. The assumptions around the Australian dollar are USD0.72 and a TWI of 62 versus USD72 and a TWI of 61 in November. In November, market pricing largely contained the expectation of a 25bp cut in the cash rate by February, which of course did not eventuate. And market pricing today largely contains the expectation of a 25bp cut by May. Consequently the assumption that is used in the forecasts (i.e. market pricing) is unchanged from November, and does not commit the Bank to any rate cut.
The most interesting discussion in the Statement is around the labour market. The Bank notes that labour market conditions improved by more than expected at the time of the November Statement. However, the Bank appears to be comfortable accepting that outcome. There are a number of indicators that are consistent with the improvement in employment, including business surveys. It is also forecasting that the unemployment rate will fall further – in contrast to the November view that the unemployment rate would be unchanged over the year ahead after which it would decline gradually. Certainly it accepts that employment growth will slow from the pace in the fourth quarter, but it is expected to remain strong enough to further reduce the unemployment rate. That includes an assumption of a further rise in the participation rate. Of course, if that participation rate assumption proves incorrect, then the Bank would be looking for an even larger fall in the unemployment rate. The Bank attributes the strong employment story to strong growth in the output of the more labour-intensive sectors of the economy, and of course the absence of any wage pressures. Westpac is also of the view that employment growth will slow, but we are less confident that the unemployment rate will fall further in the near term. This risk of the Bank being disappointed if further falls in the unemployment rate do not materialise will be a factor for policy. However, we do not believe that our forecast for an upward drift in the unemployment rate from 5.8% currently to around 6.0% would be enough to trigger a rate cut.
As has been the case in the past, China figures prominently as a risk to the forecasts, with the additional challenge for Chinese authorities now coming in the form of capital outflows. However, we assess that the Bank’s central view is still one of a manageable slowdown in the Chinese economy, while accepting that any sharp adjustment is likely to be met with a further depreciation in the Australian dollar.
In that regard, it is interesting that the Bank does not include the Australian dollar in its list of uncertainties. That may be because its current view is that the US Federal Reserve will continue with its normalisation policy – “expected increases in the US Federal Reserve’s policy rate”.
An abandonment by the Federal Reserve of this normalisation process would have significant implications for the Bank’s Australian dollar assumption and therefore additional risk to the forecasts in this Statement.
Not surprisingly, the Bank continues to point out that the outlook for non-mining business investment remains subdued in the near term, but continues to note “some of the pre-conditions for a pick-up in investment are in place”. Compensating for ongoing disappointment in the investment outlook is a somewhat more constructive view on the household sector. Consumption growth is projected to increase to a little above the long-term average on a somewhat better outlook for household incomes, based on the stronger job outlook. Indeed, the Bank is now assuming a more modest decline in the household saving ratio – if confidence holds, then spending might be even stronger given the expected better outcomes for incomes.
Finally the slowdown in housing is recognised, but there are no concerns around any major disruption to the economy. The Bank quite rightly argues that a lack of equity withdrawal during the price upswing is consistent with households coping comfortably with a period of flat to modestly lower prices.
Conclusion
The general flavour of this statement is slightly more optimistic that we had expected. It is certainly not consistent with a Bank that is near cutting rates. However, risks remain, specifically around a disappointment in the expected further improvement in the labour market and a development around the US Federal Reserve that would change the Bank’s outlook for further US rate hikes over the course of the next year or so. That second development could be expected to provide unwelcome upward pressure on the Australian dollar which would be a clear disappointment for the Bank.
You’re also behind the curve now, Bill.
