From Bill Evans at Westpac:
The Bank releases these Statements on a quarterly basis so they are very important from the perspective of tracking the policy deliberations.
In the Preview which I released recently I noted that the Governor, in his recent Statement following the November board meeting, signalled that there would be few changes (from the August Statement on Monetary Policy) in the forecasts in the Statement.
That has proved to be the case with forecast GDP growth for 2016 at 3.0%; 2017 at 3.0% and 2018 at 3.5% (nominating the mid points of the quoted ranges).
The only change has been to lower the growth forecast for the year to June 2018 from 3.5% to 3.0% – that adjustment reflects a slower increase in LNG production than had been expected in August.The Inflation forecasts are also intact. Underlying inflation is still forecast at 1.5% for 2016 and increasing to 2% in 2017 remaining there in 2018.
However, while the overall forecasts are unchanged there have been adjustments to the make-up of the growth and inflation components.
1) “Expectations for long term growth in household consumption have been lowered slightly” – a somewhat slower decline in the savings rate has resulted from slower expected employment and incomes growth.
However the impact on GDP growth is offset with an offsetting downward revision to imports.
2) “the forecast for dwelling investment has been revised up slightly”. This reflects an upward revision of the residential construction pipeline.
3) “the outlook for the level of resource exports is lower than previously expected.” The LNG production capacity has been downgraded while any offsetting assumption around coal exports has been down played on the basis that producers are already operating near full capacity and new investment is unlikely given that prices are expected to fall.
Of most interest is the view on the labour market since we expect that policy in 2017 will be significantly influenced by developments in the labour market rather than inflation. There has been a downward revision to the forecasts for employment growth with the outlook over the next 6 months being for more modest growth than expected in August. However the forecast unemployment rate is largely unchanged due to an upward revision to the forecast participation rate. The unemployment rate is expected “to edge lower” but to remain clearly above the 5.1% which is generally assessed as full employment in Australia.
Consequently the Bank is still expecting an extended period where there is spare capacity in the labour market. We are expecting faster growth and stronger employment growth than is implied by the Bank in 2017. The state of the labour market will remain the key policy driver in 2017.
The underlying inflation forecasts are unchanged.
Arguments are put forward for expecting the underlying inflation rate to lift in 2017 – the slowdown in wages growth has stabilised – an argument supported by the Bank’s liaison field studies. These studies, however, do also find that there is no “pent up demand” for larger wage increases.
Other arguments supporting a gradual pick- up in inflation are – heightened retail competition expected to diminish; long term measures of inflation expectations measures have stabilised.
Partially offsetting these arguments is the acceptance that the impact on inflation of the fall in the AUD since 2013 has largely run its course.
Despite the unchanged forecasts the Bank is still acutely aware of considerable uncertainties. As usual China figures prominently – production responses to the recent rise in coal and iron ore prices; rising corporate debt; and longevity of the housing cycle in China.
Of course the labour and housing markets are singled out for special consideration.
For the labour market the switch between full time/part time jobs risks a slower fall in the unemployment rate if demand is satisfied with longer part time hours while uncertainty around the participation rate persists.
For the housing market issues around the apartment market are highlighted – looming oversupply; which could affect prices; rents; and construction activity and jobs.
Conclusion and Outlook for Policy
With the forecasts unchanged there is little doubt that the Bank is unlikely to be initiating a policy change any time soon.
However the tone of the Statement seems to support the view that if rates are to move in 2017 it will be to the downside.
The three key themes embedded in this Statement are around: (1) the expectation of an extended period of overcapacity in the labour market with employment growth being marked down; (2) the ongoing concern of the impact of oversupply in the apartment market weighing on house prices; inflation and activity; and (3) the view that the recent boost to commodity prices will be short lived and have limited impact on incomes and investment.
We are more optimistic about employment growth (and GDP growth at 3.3% for 2017) expecting a more significant tightening of spare capacity in the labour market.
On the other hand we expect that strong pent up demand; a long construction pipeline; and buoyant foreign demand will ensure that the feared oversupply in the apartment market in 2017 will not eventuate.
We certainly buy the Bank’s argument about the sustainability of the current bulk commodity boom but are now considering that it could last for longer than implied in the Bank’s forecasts and provide a stronger boost to wages; profits and fiscal than implied by the Bank.
