RBA Watch – RBA to keep monetary policy unchanged till 2016

by: Roy Teo

  • RBA upgrades inflation outlook
  • Monetary policy to remain unchanged till 2016…
  • … rate cuts unlikely

RBA upgrades inflation outlook…

The Reserve Bank of Australia minutes released this morning showed that the central bank now expects underlying inflation to be higher by about 0.5pp due to the decline in exchange rate since early 2013. Nevertheless, inflationary pressures are expected to remain subdued given spare capacity in the labour market. On the exchange rate, the RBA reiterates that the Australian dollar remained above most estimates of its fundamental value and was offering less assistance than would normally be expected in achieving balanced growth in the economy.

RBA to keep monetary policy unchanged till 2016…

We now expect the RBA to delay tightening monetary policy till early 2016, from our previous projections of late 2015. This is due to a slower than envisaged rebalancing of the economy from the mining to non-mining sectors. Since the RBA shifted from an easing to neutral policy bias in late 2013, the recovery in both the manufacturing and service sectors have been slow. The unemployment rate has also risen from 5.7% in August 2013 to 6.20% in September this year. Due to a soft labour market, consumer confidence has also declined by more than 10% during the same period. In addition, Australia’s key commodity export prices have also slumped by almost 20%, weighing on the terms of trade and trade balance. With resource investments expected to decline significantly and non-mining investment to increase only moderately in the coming quarters, we expect economic growth to remain below trend and inflation below the RBA upper range of 3% in 2015. The sharper than expected decline in oil prices is also likely to result in more uncertainty in Australia’s natural gas investment projects. We do not expect the RBA to raise the cash rate next year to cool the housing market as interest rates is a blunt tool given the lacklustre recovery in the other sectors of the economy.

 …rate cuts unlikely

We do not think that the RBA will lower the cash rate for the following reasons. First, this will add fuel to housing market with speculative activities above the central bank’s comfort level. Second, tougher bank lending practices and macro prudential tools are likely to be favoured to curb house price growth. However we doubt that the central bank will impose very tough measures as they recognise that the strength in the housing market has been supporting household consumption despite the subdued labour market. Third, we expect the decline in the Australian dollar to improve the trade balance, push up tradable inflation and support economic growth. Fourth, there are some signs that the deterioration in the labour market has stabilised. Fifth, we expect iron ore prices to remain relatively stable above current levels of USD 80 a tonne next year. Last but not least, business confidence and conditions are improving moderately. Our view that upside in the AUD/USD towards 0.89 will not be sustainable with prices expected to head lower towards 0.86 by the end of this year remains unchanged. Our AUD/USD forecasts for 2015 and 2016 will be released later this week.