The RBA turns neutral

Chief Economist’s View

Uncharacteristically, the Reserve Bank of Australia (RBA) surprised the market this week, signalling a change in policy stance from what was a tightening bias (where the RBA expects the next move in the official cash rate to be up) to a neutral bias (where the RBA thinks the next move could be either up or down). RBA Governor Lowe unveiled the shift in stance in his address to the National Press Club, in Sydney on Wednesday, in anticipation of the release today of the Statement on Monetary Policy.

Of course, Dr Lowe did not exactly use the words neutral bias or tightening bias in his speech. As is characteristic of RBA communication, the wording was somewhat more ambiguous, but it was the following passage of Dr Lowe’s speech that clearly signalled a shift in policy stance: “Looking forward, there are scenarios where the next move in the cash rate is up and other scenarios where it is down. Over the past year, the next-move-is-up scenarios were more likely than the next-move is-down scenarios. Today, the probabilities appear to be more evenly balanced.”

Dr Lowe cited a deterioration in the global economic outlook and the Australian housing market for the shift in risks and, hence, the change in policy stance. I beg to differ. The current pace of slowdown in the global economy was well anticipated by markets and most economic commentators since around September/October of last year. In fact, consensus forecasts for economic growth in the US and China economy for 2018 and 2019 are little changed from the start of 2018 with the bulk of the downgrade to the global outlook centred on the euro area, the UK and Japan.

It is the case that risks have intensified since mid-year of 2018, including the escalation of the US/China trade war, a no-deal Brexit, a tightening in global financial conditions and a deterioration in the Australian housing market. But again, the market and most commentators had factored in these downside risks well before the end of 2018. Rather, it was the RBA that was out of step with market thinking and most economic forecasters’ views on the outlook, with an impossibly high Australian economic growth forecast. What we are witnessing is the RBA lowering its growth and inflation forecasts to be more in line with the consensus view.

What is the RBA’s new growth and inflation outlook? The RBA has lowered its average annual growth forecast in 2019 and 2020 from 3¼% to a trend rate of 2¾%. Its year-ended forecasts for underlying inflation in 2019 have fallen from 2¼% to 2%, while leaving its 2020 forecast of underlying inflation unchanged at 2¼%. While the RBA’s year-ended unemployment rate forecasts are unchanged at 5% (2019) and 4¾% (2020), the leg down from 5% to 4¾% has been shifted back six months from June 2020 to December 2020. How should we interpret the RBA changes?

The RBA’s baseline forecast now lines up almost exactly with the consensus view (as expressed by Bloomberg’s survey of professional forecasters). The outlook is one of an economy stabilising at trend growth, with unemployment easing below the NAIRU and underlying inflation gradually forcing its way back within the RBA’s target band of 2% to 3%. If this outlook pans out, there will be no pressure on the RBA to cut the cash rate. The question remains, when will the RBA raise rates?

This is where the RBA’s commentary on the balance of risks becomes important. As mentioned, the RBA has signalled two key downside risks: (i) a slowing global economy and (ii) the correction in the domestic housing market. The consensus view on the global economy is that it will continue to slow over 2019 and into 2020 and US/China trade wars, Brexit, and question marks over the European and Japanese economies are unlikely to be fully resolved until 2020. Similarly, the downturn in the Australian housing market will continue to play out over 2019 and the first half of 2020.

Based on our, consensus and the RBA’s outlooks, we anticipate that the global economic and domestic housing market pictures will gain clarity over the first half 2020. We then anticipate that the RBA will wait well into the second half of 2020 to allow the full impact of the slowdowns to work their way through the Australian economy, before raising rates in the December quarter of 2020.

Table 1: Financial market movements, 31 January – 7 February 2019

Equity index

Level

Change

10-yr government bond

Yield

Change

Foreign exchange

Rate

Change

S&P 500

2,706.1

0.1%

US

2.66%

2.8 bps

US Dollar Index (DXY)

96.51

1.0%

Nikkei 225

20,751.3

-0.1%

Japan

-0.01%

-1.3 bps

USD-JPY

109.86

1.2%

FTSE 100

7,093.6

1.8%

UK

1.18%

-4.2 bps

GBP-USD

1.290

-1.8%

DAX

11,022.0

-1.4%

Germany

0.12%

-3.4 bps

EUR-USD

1.134

-1.2%

S&P/ASX 200

6,092.5

3.9%

Australia

2.15%

-9.4 bps

AUD-USD

0.711

-2.3%

Source: Bloomberg

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