Australian interest rates February 2017

Australian interest rates: RBA on hold sounding more confident in the outlook.

RBA leaves rates on hold ...

As expected the Reserve Bank Board decided to hold the overnight cash rate unchanged at 1.5% in February. More notable is a clear shift in tone in the Governor’s decision statement, re-emphasised in a speech and the Bank’s quarterly Statement on Monetary Policy (SoMP) in the days following. While its forecasts are largely unchanged, the Bank is sounding a little more comfortable with the outlook and uninclined to move rates any time soon.

... as Bank more comfortable with outlook.

Four specific positives stand out: the Bank remains unfazed by the surprise contraction in Q3 GDP; the bulk of the mining investment wind-down is now seen as having passed; the multi-year decline in the terms of trade is assessed as over; and the outlook for global growth has been upgraded.

The Bank’s growth forecasts for 2017 and 2018 are little changed from November. Over the next couple of years GDP growth is still expected to be around the 3% mark. That is a little above trend, which is judged to be 2.75%, and therefore implies a gradually strengthening labour market. The point forecasts were in keeping with our priors. For December 2017, the RBA expects GDP growth to be 3.0%, unchanged from three months earlier. Westpac Economics is also forecasting 3.0% growth over this period. For December 2018, the RBA expects growth to lift to 3.25%, albeit downgraded by 0.25% from the November SoMP. Note that the Federal Government in their December MYEFO lowered year average growth for 2017/18 to 2.75% from 3.0%. Westpac Economics is less optimistic than the RBA on the 2018 outlook, anticipating growth to moderate to 2.6%yr, constrained by a downturn in home building activity.

RBA expects growth to be a little above trend ...

RBA Governor Lowe in his recent speech emphasised a few key points shaping the RBA’s thinking around the outlook. Notably, the headwinds from the unwinding of the biggest mining investment boom in a century will blow themselves out. The RBA assesses that we are already around 90% of the way through the fall from the peak to expected trough in mining investment. Another headwind experienced over recent years, the decline in the terms of trade, has already stopped. Since around mid-2016, a rise in global commodity prices has provided a boost to national income.

... at around 3% mark in 2017 and 2018 ...

An improvement in the global economy since last year will also assist. The RBA upgraded its commentary on world growth between December and February – going from being described as “lower than average” to having “improved over recent months”. Growth is expected to be above trend in a number of advanced economies (incorporating the prospect of more stimulatory fiscal policy in the US), and has been stronger than expected in China.

... supported by improved global backdrop.

In short, with the end of the unwinding of the mining investment boom in sight, the Governor views the economy as being in reasonable shape. The surprise contraction in GDP in the September quarter 2016 is discounted, with the Bank arguing that it largely reflected a confluence of temporary factors. The RBA assesses that the economy returned to reasonable growth in the December quarter. That said, on the consumer there is a more cautious view from the RBA, with growth forecasts for this component pared back after the soft patch in Q2 and Q3. Notably household savings rates are now expected to hold steady. Previous Bank forecasts had a declining savings rate giving a slight ‘tail-wind’ to demand.

Key areas of concern - labour market, housing and inflation ....

Areas of focus for the RBA remain the labour market, housing and inflation. Specific commentary on the labour market is largely unchanged, with conditions described as mixed although the Bank notes that leading indicators are pointing to continued expansion. Commentary on the housing market is also largely in line with the December statement with the market described as strengthening overall and prices rising briskly in some cities. There is also some emphasis on the tightening in lending conditions from the banks that will give the RBA some comfort with respect to any financial stability risks. Commentary around inflation remains confident pointing out that the most recent inflation report was in line with expectations and both headline and underlying inflation were expected to rise above 2% over the Bank’s forecast period.

... less troubling for now, consistent with rates on hold.

The February decision statement clearly sets out the Bank’s current policy approach. That is, to hold rates steady in anticipation of a gradual lift in growth and inflation while imbalances in the housing market remain contained. We expect this thinking will be sustained throughout 2017 being supported by a rising terms of trade, a peaking construction cycle and a gradually falling unemployment rate with rates remaining on hold. Our central view for 2018 would be a similar policy stance despite clear preferences in the market for the beginning of a tightening cycle. Westpac’s view on growth in 2018 is that it will slow to a below trend 2.6% with housing construction contracting, the terms of trade falling, and ongoing moderation in consumer spending and business investment. This pitches the risks to the “on hold” call in 2018 to the downside in clear contrast to current market views.

Bill Evans, Chief Economist

Reproduced from the February 2017 edition of Westpac's market outlook

Business focus also has the following articles from the February 2017 edition of Westpac's Market Outlook;

Australian dollar February 2017

The Australian economy February 2017

Past performance is not a reliable indicator of future performance. The forecasts given above are predictive in character. Whilst every effort has been taken to ensure that the assumptions on which the forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The results ultimately achieved may differ substantially from these forecasts.