Reserve Bank retains hope on the outlook
Statement on Monetary Policy
Reserve Bank Statement: Looking out over the next 12-18 months, the Reserve Bank tips stronger economic growth, a modest lift in inflation and slightly lower jobless rate than applies currently. So the Reserve Bank assumes that the economy is headed in the right direction.
The Statement on Monetary Policy can affect financial market pricing and it provides a roadmap for businesses.
What does it all mean?
• Six months ago we said “It all gets down to jobs.” And that point has clearly been emphasised by the Reserve Bank in the period since. If the Reserve Bank decides to cut interest rates further in coming months it will be because there is no progress made in reducing spare capacity.
• The latest forecasts assume a small fall in the jobless rate over the next 12-18 months with no change in inflation (2.0 per cent expected) but firmer economic growth. The forecasts assume “one 25 basis point cut in the cash rate by the end of this year, to 0.75 per cent, and a further 25 basis point cut in the first half of 2020.” The bottom line is that the economy is heading in the right direction, but it may take further rate cuts to achieve the better outcomes.
• The forecast assumptions are important. If economic growth, inflation and unemployment don’t improve by more than expected then further rate cuts will occur. But the Reserve Bank will continue to apply pressure on governments to lift spending, especially on infrastructure.
• The Reserve Bank Governor has today made it clear that rate cuts remain possible. All major global central banks are expected to cut rates in coming months. If global rates were headed towards zero, the Governor said that this would be something that the RBA would have to think about. The Governor stresses though that the central economic scenario was one where the economy gradually improves from here.
Key messages from the Reserve Bank report
• Below are some additional key messages from the Reserve Bank’s latest quarterly review. The full Statement on Monetary Policy can be found here:
• Key Paragraph: “Given the current environment, it is reasonable to expect that an extended period of low rates will be needed to achieve the Board’s employment and inflation objectives. The Board will continue to monitor developments in the labour market closely and is prepared to ease monetary policy further if needed to support sustainable growth in the economy and the achievement of the inflation target over time.”
• Global outlook: There is considerable uncertainty about possible future tariff measures and the potential for global technological standards to become fragmented. This uncertainty has weighed on investment and investment intentions in a number of economies, and poses a significant risk to the global outlook.
• Inflation forecast: “inflation is still expected to drift up gradually. However, this is now forecast to take place over a more extended period than previously envisaged, because there appears to be more spare capacity remaining in the labour market than had been thought.”
• Spare capacity: “Together, the recent data on wages, prices, output and unemployment suggest that there was more spare capacity in the economy than had previously been recognised. They also suggest that, like a number of other countries, Australia can sustain lower rates of unemployment and underemployment without running inflation risks.”
• Investment: “The investment outlook in Australia more generally is broadly positive.”
• Consumption: “The outlook for consumption more broadly continues to be the main uncertainty facing the domestic economy, especially in the context of ongoing high levels of household debt.”
• Housing: “A more positive signal for future consumption is that established housing markets appear to have stabilised.”
• Job market: “Leading indicators point to a moderation in employment growth in the period ahead.”
• Aussie dollar: The Australian dollar has depreciated over recent months and is at its lowest level of recent times. The depreciation over the past year is consistent with the decline in Australian bond yields relative to those in other major markets over that period.
• Wages: “Wages growth is expected to remain stable over the next year…there is limited upward pressure stemming from current labour market conditions and the majority of surveyed firms in the liaison program now anticipate little change in wages growth over the next year.”
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 in assessing the short-term outlook for interest rates.
What are the implications for interest rates and investors?
• The Reserve Bank is expected to leave rates stable until November. At the November Board meeting the Reserve Bank will have three more months of job data as well as economic growth and inflation data.
• Investors will need to work on the assumption that low rates are here to stay for quite some time. That will mean more money going into the sharemarket and thus changing perspectives on what is ‘fair value’ for shares (the price-earnings ratio). In other words a higher PE ratio may be considered more ‘normal’ in a low inflation/lower interest rate environment.
Published by Craig James, Chief Economist, CommSec