Australia’s RBA sees better economic conditions, cuts inflation forecast

Mortgage rate hikes from the banks won’t be enough to force the RBA’s hand on Melbourne Cup day.

The Reserve Bank of Australia has left interest rates on hold.

The fact that the Bank included this statement despite noting that “prospects for an improvement in economic conditions had firmed a little over recent months” highlights to analyst Felicity Emmett at ANZ Research the importance of the 2-3% target band for inflation for the Bank. Speeches on Thursday by Mr Stevens and his deputy Philip Lowe and the RBA’s quarterly monetary policy statement on Friday – which contains its latest inflation and economic growth forecasts – will pad out the central bank’s thinking on the outlook.

“It would be good if the growth was a bit stronger, but nonetheless over the past year the non-mining side of the economy has generated respectable growth in employment”, Stevens told an economics conference.

Like other resources-dependent economies, Australia has been hit by slowing growth in China, its largest trading partner and the world’s biggest commodities consumer.

As the RBA noted, moreover, only “some” lending rates increased – namely variable rate housing loans – and not fixed rate home loan or business rates. “AUD has actually gained as interest rate expectations have declined sharply, at least partly reflecting gains on the basis of rising risk appetite”. The central bank unveiled 25-basis point cuts at two consecutive meetings later that year.

Rate rises put through by the major banks, and low inflation rates in the September quarter are the main drivers of a potential rates cut, either on Tuesday or in December.

In contrast to the frequently Delphic utterances of American and European central bankers, Reserve Bank Governor Glenn Stevens’ public pronouncements are mostly matter-of-fact and free of artifice.

With such a benign inflation outlook, should the domestic economy require additional monetary policy stimulus, there is clearly room for the RBA to move if required.

In February this year, the RBA adopted a new assumption around the interest rates being used to drive its forecasts.

Underlying inflation was now seen around 2 percent for most of next year, down from 2.5 percent previously, and then to rise to around the middle of the 2 to 3 percent target range.

Swaps markets see a 67 per cent chance that the RBA holds policy unchanged next month, and a better than 70 per cent chance of a reduction in the first quarter of 2016.

As discussed, the RBA will need to assess all of these factors as pointing to a downward revision to growth in 2016, from its current 3.00 per cent to a below trend 2.50 per cent, to trigger lower rates.