Australian interest rates June 2017

Australian interest rates: firmly on hold as RBA reaffirms positive growth view.

Cash rate going nowhere ...

As expected, the RBA left the official cash rate unchanged at 1.50% at its June meeting with what looks to be a ‘firmly on hold’ policy stance. We continue to expect the cash rate to remain unchanged over the remainder of 2017 and throughout 2018.

... the RBA showing no clear policy bias ...

The Governor’s statement accompanying the June decision again offered nothing in the way of explicit policy guidance, concluding simply that: “holding the stance of monetary policy unchanged at this meeting would be consistent with sustainable growth in the economy and achieving the inflation target over time”.

... but reaffirming its positive medium term growth view.

However, there were some notable changes in the commentary. In particular, the statement acknowledged weaker commodity prices and the slower picture around growth. Both were downplayed – price declines “as expected” and the growth slowdown “reflecting the quarter to quarter variation in growth figures”. More pointedly, the Governor commented that growth is “… still expected to increase gradually over the next couple of years to a little above 3 per cent”. To say this the day before a quarterly national accounts release that some feared would show an economic contraction is to send a fairly clear message – the Bank seemingly going out of its way to reaffirm its positive medium term view.

Some minor shifts in emphasis ...

Other commentary in the Governor’s statement was more mixed. The discussion around business investment was a little more constructive (the mining investment downturn “almost complete”, business conditions have improved, capacity utilisation tighter and investment lifting in ‘non mining’ states) but comments on the labour market were a touch less confident (May’s line that “the unemployment rate is expected to decline gradually over time” dropped). On housing, the Bank again noted that “prices have been rising briskly in some markets” but added that “there are some signs that these conditions are starting to ease”. On the AUD, the standard line that a rising exchange rate would complicate the transition from the mining investment boom was retained.

... but no substantive changes ...

Dissecting the Governor’s decision statement can be tricky, particularly distinguishing simple statements of fact from shifts in emphasis and thinking. While there is always room for speculation, most of the changes this month seem to be acknowledging developments rather than marking a shift in the Bank’s core views.

... with housing again prominent in the policy discussion.

The structure of the statement is worth noting. The most important concluding paragraph is completely unchanged, stating policy was unchanged and giving no forward guidance. The penultimate paragraph discusses housing market conditions, a key area of concern for the Bank according to its most recent minutes and the focus of its latest macro-prudential policy measures. Other discussion points are given less prominence.

Our ‘no change’ view on rates ...

All up, we see no reason to change our long held view that the official cash rate will remain on hold throughout 2017 and 2018, particularly given the strong May labour force figures released the week after the June RBA meeting. Market pricing shows a similar profile near term but 3yr swap rates are still leaning towards rate increases further out.

... is despite a weaker growth forecast ...

Note that our ‘on hold’ call is despite Westpac’s materially weaker growth forecast for 2018: 2½% vs the RBA’s 3¼%. This reflects a view that the Bank will be very reluctant to move rates lower from here. The RBA has restarted the current easing cycle twice already: in early 2015 and in mid 2016. In 2015, the catalyst was a sharp slide in commodity prices that was set to impact incomes at a time of already sub-par growth and gradually rising unemployment, with a benign inflation backdrop giving the Bank scope to move. In 2016, the catalyst was a sharply weaker profile for inflation which, given a drop in wages growth, was threatening to stay well below the RBA’s 2-3% target range for an extended period.

... and reflects the Bank’s evolving views on financial stability risks ...

Housing markets were an important conditioning factor in both periods. The 2015 rate cuts coincided with a material tightening in macro-prudential policy (the introduction of a 10% ‘ceiling’ for annual growth in investor housing credit) designed to cool activity and contain potential financial stability risks. The success of these policies and comfort around housing related risks then gave the RBA a freer hand to move rates again in 2016.

The Bank’s thinking has evolved since then. The 2016 cuts quickly reignited housing markets (albeit focused more narrowly on Sydney and Melbourne) prompting another round of macro-prudential measures. While markets are now slowing again the RBA will be wary of adding more interest rate stimulus to the mix.

... which will continue to factor in deliberations.

Housing and household debt are not the only considerations for monetary policy but they are clearly a factor in current deliberations. As such, the case for further policy stimulus would need to be very strong – a more material weakening in the growth outlook than our 2½% forecast (which is still only ¼ppt below ‘trend’) and a clearer downside threat to the medium term inflation view. The Bank would also have to be convinced that a further cut in rates would deliver a significant enough boost without leading to unacceptable financial stability risks down the line.

Matthew Hassan, Senior Economist

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

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

Australian dollar June 2017

The Australian economy June 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.