FX comment – RBA downgrades GDP and inflation forecast; weaker AUD expected

by: Roy Teo

  • RBA downgrades GDP and inflation forecast
  • AUD to decline as RBA continues easing cycle later this year

 

RBA downgrades GDP and inflation forecast

The Reserve Bank of Australia (RBA) now projects that the economy will expand at below trend pace for a little longer than anticipated before picking up over 2016/17. Economic growth in 2015-16 has been lowered from 2.5-3.5% to 2-3%, reflecting weaker than expected growth in China. Core inflation has also been revised lower and is not expected to rise above the upper bound of 2-3% inflation target over the next two years. Excess capacity in the labour market is also forecast to be longer than previously assessed. As a result wage growth is not expected to increase much over the next two years. In addition, the terms of trade has been revised down by about 1.5% due to decline in commodity prices in recent months.  Mining investment is expected to fall significantly while non-mining investment is not likely to pick up over the coming quarters. The decline in commodity prices has resulted in production cuts by higher cost producers. This pose downside risk to export growth. The RBA also noted that strong house price growth in Sydney (due to supply constraints) was not evident across the rest of the country. Further depreciation in the exchange rate seems both likely and necessary.

AUD to decline as the RBA continues easing cycle later this year

Financial markets have started to price out the probability of further rate cuts since the RBA shifted from an easing to neutral bias in the recent monetary policy meeting on 5 May. That has supported the Australian dollar (AUD). We still see a case for the RBA to cut the Official Cash Rate by 25bp to 1.75% later this year given the slow rebalancing in the economy and stronger than desired exchange rate. We continue to expect a weaker AUD towards 0.72 by the end of this year as the economic and monetary policy divergence between Australia and the US widens.