Reserve Bank will lift interest rates “at some point”RBA Statement on Monetary Policy; Chinese economic data
Forecasts: The Reserve Bank has made no changes to its forecasts for economic growth. Headline inflation forecasts are unchanged too. However, near-term underlying inflation forecasts have been increased from 1.75 per cent to 2 per cent for both June 30 and December 31, 2018 year ends. Forecasts for the near-term unemployment rate have also been increased. The unemployment rate is now forecast to be 5.5 per cent in 2018, up from previous forecasts of 5.25 per cent.
Interest rate outlook: “If the economy continues to perform as expected, higher interest rates are, however, likely to be appropriate at some point. Notwithstanding this, the Board does not see a strong case for a near-term adjustment in the cash rate.”
China purchasing managers’ index: The Caixin services purchasing managers’ index rose by 0.6 points to 52.9 points in April, above market forecasts for 51.9 points. Results above 50 points imply expanding activity.

What does it all mean?
The Reserve Bank Governor Philip Lowe spoke at the Board dinner in Adelaide on Tuesday night and told us that there would be few surprises in today’s Statement on Monetary Policy. And so it proved. As widely expected, interest rates are not increasing in the foreseeable future.
The defining sentence in the May Statement is: “If the economy continues to perform as expected, higher interest rates are, however, likely to be appropriate at some point. Notwithstanding this, the Board does not see a strong case for a near-term adjustment in the cash rate.”
The Reserve Bank remains optimistic that the Aussie economy is improving stating that “growth in the domestic economy is expected to have picked up in the March quarter, as coal exports recovered from disruptions to supply and liquefied natural gas (LNG) exports increased further. Recent data, including revisions to prior quarters, imply that there was a bit more momentum in domestic demand in the second half of 2017 than previously reported.” While there were no changes to the economic growth projections, “growth is still expected to be a bit above 3 per cent from late 2018. Growth at these rates would typically imply that spare capacity will continue to be absorbed.”
With underlying inflation already close to 2 per cent in the March quarter the Bank increased its near-term forecasts from 1.75 per cent to 2 per cent in 2018. Underlying inflation isn’t expected to increase again until mid-2020.
Retail deflation and slow wages growth remains key concerns for the inflation outlook. The Bank reiterated that “subdued growth in labour costs and ongoing competition in retailing are weighing on inflation. Prices of durable goods and many other consumer staples have accordingly been little changed or have fallen over recent quarters. Some of this downward pressure should ease as the labour market tightens and wages growth picks up.”
Unemployment is expected to remain sticky at around 5.5 per cent throughout 2018, up from previous expectations for 5.25 per cent. While the labour market has been very strong over the past 12 months or so, the Board stated that “…there is still spare capacity in the labour market: the unemployment rate is around ½ percentage point above conventional estimates of full employment in Australia. A broader measure of labour market underutilisation, which captures the additional hours that underemployed people would like to work as well as hours of work sought by the unemployed, has declined over the past year, but remains elevated.”
The Board remains positive, however, regarding developments in the jobs market it advised that “information from business surveys and the Bank’s liaison program provide evidence of emerging labour shortages in some parts of the economy”. However, “measured labour productivity growth has been low for several years”. In other words, wages growth will only be gradual, thus keeping inflation low and interest rates stable in the near-term.
What do the figures show?
Key messages from the Reserve Bank report
Below are some additional key messages from the Reserve Bank’s latest quarterly review.
On economic growth: “…GDP growth is currently around estimates of potential growth in year-ended terms.”
On business investment: “The outlook for non-mining business investment is for continued expansion. An increasing number of firms are reporting that they face capacity constraints, and survey measures of investment intentions also suggest that further solid growth in investment is likely.”
Employment outlook: “..leading indicators point to the possibility that the unemployment rate could fall faster than expected in the near term; the fact that GDP is expected to grow faster than trend over the forecast period is also consistent with this possibility”.
On wages growth: “As the labour market tightens, wages growth is expected to pick up gradually… The extent to which a pick-up in wages growth will translate into inflationary pressures will depend on whether there is an accompanying increase in productivity growth”.
The household sector outlook: “Housing assets account for around 55 per cent of total household assets, so weaker housing prices could be a factor that leads to weaker consumption growth than is currently forecast.. Steps taken by regulators to strengthen household balance sheets have led to a moderation in the growth in the riskier types of lending to households, but risks remain.”
On ‘trade wars’: “There is a risk that an escalation in protectionist measures or geopolitical events could harm global growth”.
On rising short-term interest rates: “The developments in US dollar money markets have had a noticeable knock-on effect on Australian money market rates. In part, this is because Australian banks raise a portion of their funding in US markets to finance their domestic assets. So they have responded to higher US rates by seeking to borrow more in domestic markets, which has place upward pressure on rates in Australia.”
What is the importance of the economic data?
The Reserve Bank releases its Statement on Monetary Policy each quarter. The Statement is the Reserve Bank’s assessment of economic and financial conditions and also contains the latest inflation views. The Statement is crucial is assessing the shortterm outlook for interest rates.
What are the implications for interest rates and investors?
Interest rates are on hold. The next move in rates is up if the Reserve Bank’s scenario plays out.
The Reserve Bank Governor remains upbeat, expecting the economy to grow above 3 per cent in 2018 and 2019. Combined with a positive global backdrop, domestic growth is likely to be underpinned by a further pick-up in nonmining business investment, steady but firm household consumption growth, rising LNG exports and supportive government-led infrastructure spending.
The unemployment rate is expected to eventually decline with the tightening labour market gradually boosting labour cost pressures. Inflation is forecast to increase steadily, enabling a very patient Reserve Bank to lift interest rates from record lows of 1.5 per cent for the first time since August 2016 in either late 2018 or early 2019.
China’s services sector is expanding, implying robust growth momentum and solid domestic demand.
CommSec expects no change to official interest rates until at least the December quarter. But the extremely slow lift in wage and price growth suggests the first rate hike in the new cycle won’t appear before February 2019.
Published by Ryan Felsman, Senior Economist, CommSec