Macquarie is spot on:
The February Board meeting will consider updated forecasts for growth and inflation before making the first rates decision of 2017. Over the days that follow, the RBA staff will make adjustments before publishing the February Statement on Monetary Policy (SoMP).
Our base is that the RBA will keep rates on hold at this meeting, with a cut coming in May. However, whilst there are pressures from a financial stability perspective, the forecast backdrop is one that could easily see the RBA justify a surprise rate cut.
The RBA will extend their forecast horizon in the February SoMP, out to June-2019. That’s helpful, given the downside pressures on the inflation outlook.
Although the 4Q16 CPI outcome was in line with the RBA’s November SoMP expectations, outcomes for other key forecast variables all represent a source of downside risk to the inflation outlook.
The most obvious of these is the 3Q16 GDP outcome, which saw the economy contract by 0.5%QoQ – only the 4th contraction in 25 years. The outcome was well outside the RBA’s range of forecast outcomes. And although partial economic data for 4Q16 suggests that Australia has avoided a recession, it is not pointing to a strong growth rebound. On net, the economy is smaller, and weaker, than the RBA was expecting.
Weaker outcomes for the economy are also evident in the labour market. The unemployment rate has risen over 4Q16, finishing 2016 at 5.8%. We estimate that the RBA’s forecast had incorporated a decline in the unemployment rate to 5.6%. Lastly, the currency has been appreciating since the November SoMP. On a trade-weighted basis, the A$ is at a 2-year high, and is more than 2% higher than the November SoMP forecast.
Elevated commodity prices are a key support for the A$. Indeed, the RBA’s commodity price index, in US$ terms, is more than 50% higher than a year ago. However, as we highlighted in our outlook (2017 outlook – Finishing in style) there may be delays, or degraded, transmission of commodity price gains into domestic demand in the current episode – leaving the RBA with an A$ that’s looks right based on commodities, but remains wrong for the economy.
Net outcome: On balance, we think the RBA will downgrade their near-term growth outlook slightly to reflect the weaker starting point, but maintain their expectation for a return to above-trend growth. And as such, maintain an expectation that inflation returns to the mid-point of the target band – albeit at a slightly slower pace than previous, but still within the (now extended) forecast horizon. Net-net, just enough to keep rates on hold, whilst keeping the door open for a May, or later, rate cut.
No-brainer hold today. Forced to cut later. Just waiting for APRA to wake up.