From Westpac chief economist, Bill Evans:
August RBA Statement on Monetary Policy – as expected, forecasts unchanged but commentary indicates that the Bank retains an easing bias.
In its Statement on Monetary Policy (SoMP) for August the Reserve Bank has made no significant changes to its forecasts. This is an unusual development given that it cut rates earlier this week. Our scrutiny of previous rate decisions shows that on all previous occasions a rate change has been followed with a forecast change.
However, as indicated in previous notes we expected no forecast change and a rate cut on the basis that the changes to the inflation outlook in the May SoMP were so significant that a follow-up move would be necessary without any further need to change the forecasts.
In summary, the Bank, which has extended the forecast period from June 2018 to December 2018, has retained a 3% growth forecast for 2016 and 2017, and a 3½% forecast for the whole of 2018 (having forecast 3½% for the year to June 2018 in the May SoMP).
The inflation forecasts also remain the same: underlying inflation in 2016 is forecast at 1½% (mid-point of 1-2% range) and 2% (mid-point of 1½-2½% range) in 2017. One area of interest was whether the Bank would adopt an above 2% forecast for calendar 2018. Note that in May, the forecast to June 2018 was still 2% but there was scope in this statement to adopt a ‘with-in target zone’ forecast for 2018. However the Bank has decided to retain the 2% forecast (mid-point of 1½-2½% range) for the whole of 2018.
This means that with underlying inflation printing 2% for 2015, the Bank is predicting that underlying inflation will remain below or at the bottom of the band for four consecutive years. Indeed in the statement it is even more confronting than that, choosing to note “inflation is likely to remain below 2% over most of the forecast period”.
This approach certainly raises issues around whether, with a new Governor being appointed in September and adopting a new agreement with the Government, a revised approach to inflation targeting could be embraced. One approach might be to further extend the forecast period with an assertion that eventually inflation will return to the target zone; another might be to lower the specific target; while a third might be to abandon an actual arithmetic target. These issues will be revealed over the next few months.
As is the normal practise, the forecasts assume unchanged AUD and oil prices but adopt market pricing for interest rates. Despite the rate cut in August markets continue to fully price in another cut by early next year. So in comparing the forecasts in May, which also had one full cut priced in, these forecasts have an extra cut priced in. Yet they have not been changed to reflect even easier monetary policy.
So, from this perspective, even though the forecasts have not been changed the implication is a more cautious view than we saw in May.
The growth forecasts appear to be on the high side. We know the Bank assesses trend growth as 2.75% and these forecasts indicate the expectation of four consecutive years of growth above that trend. With that in mind it is very interesting that the commentary in the introduction to the statement, which is generally accepted to have been written by the Governor, notes the following: “While the prospects for growth in economic activity are positive there is room for even stronger growth”. Interpreting this statement is not clear cut. It may be specifically justifying the decision to cut in August or it may be providing guidance for the future. Given that it will clearly be so closely scrutinised it would be risky to dismiss it as only justifying the August decision. Along with the surprisingly downbeat commentary on the inflation outlook it should not be dismissed as only providing an explanation for the August decision.
Therefore the combination of a decidedly underwhelming inflation forecast with recognition that even though growth is expected to be consistently a little above trend throughout the forecast period there is scope for even stronger growth should clearly be interpreted as the Bank retaining its easing bias. While there is no specific guidance around the outlook for policy, which is usually the vehicle for signalling such a bias, the flavour around these forecasts and the commentary indicates that easing policy stance.
The commentary around the outlook for the economy lacks confidence. Weak wages growth is explained by ongoing spare capacity in the labour market; low inflation expectations and profit pressures. Spare capacity in the labour market is expected to persist for the full forecast period (out to end 2018) and the unemployment rate is not expected to fall too much. In the near term, employment growth over the second half of 2016 is expected to be modest. Further uncertainty around the labour market is noted with the observation that: “Gains in employment continue to be mostly in part time and among workers who would like more hours” raising the prospect that the degree of spare capacity is larger than implied by the unemployment rate. The emphasis on this mix of jobs growth has increased significantly since the last SoMP with, despite the rate cut, the mood around the labour market being more cautious.
There are also confident observations made about risks to overstimulating house prices with house price growth being assessed as modest since around April and inflation in rents easing to multi-decade lows. Further the Statement asserts that, “the risks associated with high and rising household leverage and rapid gains in housing prices have diminished.”
Of course, uncertainty prevails around the AUD: “It [the AUD] … represents a significant source of uncertainty for the forecasts for inflation as well as the outlook for growth in activity”.
Views around the international environment are broadly the same as we saw in May with no particular strong reaction to ‘Brexit’ or the political uncertainty in the US. As with previous statements considerable attention is given to China with the ongoing issues of the sustainability of the recent upswing in housing activity and the increasing imbalance from excessive corporate and local government debt attracting attention. It is reasonable to conclude that the Bank’s developing suspicions around China’s outlook have progressed further in this statement.