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RBA holds rates, flags GDP growth downgrade

David Scutt
* The RBA kept its cash rate unchanged at 1.5% in February, as expected. * It flagged downgrades to its upcoming GDP growth forecasts and warned that "downside risks have increased". * The bank still sees inflation returning "gradually" the midpoint of its target, implying it still believes the next move in the cash rate is likely to be higher, eventually. * Financial markets now see the probability of a 25 basis point rate cut by the end of the year at just under 50%. * Governor Philip Lowe will deliver his first speech of the year on Wednesday. * * * The Reserve Bank of Australia (RBA) is growing less confident about Australia's economic outlook, flagging downgrades to its GDP growth forecasts and warning that "downside risks have increased". "The central scenario is for the Australian economy to grow by around 3% this year and by a little less in 2020 due to slower growth in exports of resources," Governor Philip Lowe said. "As is the case globally, some downside risks have increased." Previously, the RBA saw the Australian economy growing by 3.25% this year and 3% in 2020. However, despite the noticeable deterioration in recent Australian economic data, the bank decided to keep its cash rate unchanged at 1.5% in February, a result that was widely expected by financial markets. It also pushed back against growing market expectations that it may be forced to cut interest rates again this year, retaining faith that above-trend economic growth will help to gradually lift inflationary pressures in the years ahead. "Further progress in reducing unemployment and having inflation return to target is expected, although this progress is likely to be gradual," Lowe said. "Taking account of the available information, the Board judged 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." While the growth downgrade implies that progress in returning inflation to midpoint of its target may be even more gradual than before, by stating that it still sees that occurring, it suggests it still believes the next move in the cash rate is likely to be higher. "The central scenario is for underlying inflation to be 2% this year and 2.25% in 2020," Lowe said. That view is similar to that communicated by the bank three months ago. Underlying inflation is likely to return to within its target band, but not the the midpoint over the forecast horizon. In the year to December, underlying inflation grew by 1.75%. It has undershot the RBA's target for three consecutive years and appears to be decelerating further. Despite receiving a string of weak indicators on household spending in the second half of last year, Lowe remained optimistic that incomes and consumption levels will improve. "GDP growth in the September quarter was weaker than expected. This was largely due to slow growth in household consumption and income, although the consumption data have been volatile and subject to revision over recent quarters," he said. "Growth in household income has been low over recent years, but is expected to pick up and support household spending." That view reflects that labour market conditions, in his opinion, "remains strong", seemingly an upgrade to the view communicated in December when he said they were "positive". "A further decline in the unemployment rate to 4.75% is expected over the next couple of years," he said. "The vacancy rate is high and there are reports of skills shortages in some areas. "The stronger labour market has led to some pick-up in wages growth, which is a welcome development. "The improvement in the labour market should see some further lift in wages growth over time, although this is still expected to be a gradual process." Lowe did not mention the recent decline in ANZ's job ads series, nor the falls in employment seen in recent PMI reports released by the Ai Group. The expected decline in unemployment mirrors the forecasts previously offered by the bank. However, despite the belief that stronger labour market conditions will help to lift incomes and household spending in the period ahead, Lowe added a caveat on that view. "The main domestic uncertainty remains around the outlook for household spending and the effect of falling housing prices in some cities," he said. Mirroring his assessment on the jobs market, Lowe noted that Australia's growth outlook was being supported by "rising business investment and higher levels of spending on public infrastructure". There was no mention of the plunge in Australian business conditions in December that fell by the most since the GFC. However, a similar result in January could see Lowe's optimism on business investment begin to ebb. On the housing market, an area of the economy that has deteriorated noticeably recently, particularly in Australia's southeastern states, Lowe said that Sydney and Melbourne are "going through a period of adjustment, after an earlier large run-up in prices". "Conditions have weakened further in both markets and rent inflation remains low." He noted that "credit conditions for some borrowers are tighter than they have been" with credit growth to investors slowing "noticeably" while that to owner-occupiers had "eased". According to CoreLogic, Australian capital city home prices fell by 1.3% and 1.2% respectively in December and January. The December decline was the largest in percentage terms since 1983. That, along with tighter lending standards, contributed to a steep decline in Australian building approvals and new home sales late last year. Again, there was no mention of those data points in the condensed policy statement. The bank may have to say in the more expansive meeting minutes. ## Global slowdown Internationally, Lowe acknowledged that global growth slowed in the second half of the year, including in Australia's largest trading partner, China. "The outlook for global growth remains reasonable, although downside risks have increased. The trade tensions are affecting global trade and some investment decisions," he said. "Growth in the Chinese economy has continued to slow, with the authorities easing policy while continuing to pay close attention to the risks in the financial sector." The recent increase in financial market volatility was also mentioned, although Lowe suggested that overall financial conditions "remain accommodative", an outcome partially helped by a shift in policy direction from the US Federal Reserve. "Market participants no longer expect a further tightening of monetary policy in the United States," he said. "Government bond yields have declined in most countries, including Australia." So what to make of the RBA's latest offering? In short, it remains confident, at least publicly, that it will eventually achieve its inflation mandate, an outcome that will likely see it repeat its previous view that the next move in the cash rate will likely be higher, in time. However, whether that remains the case is questionable given recent signals from some key parts of the Australian economy. Household consumption looks like it was weak again in the December quarter, as it was three months earlier. Building approvals are falling sharply, and could begin to drag on economic activity earlier than what was expected. There's also plenty of evidence in recent PMI and business confidence reports that suggest momentum across the boarder economy is slowing. Right now, apart from government investment, commodity revenues and labour market conditions, the signals are not looking all that great. Given so many of the RBA's forecasts are underpinned by the need for stronger job market conditions, if there's signs that they too are starting to weaken noticeably, the RBA may be forced to question its view that higher rates will eventually be warranted. We'll hear more from Governor Lowe tomorrow when he delivers his first speech of the year. That will be followed by the RBA's quarterly statement on monetary policy, including fresh economic forecasts, on Friday. The full February monetary policy statement can be accessed here.
  • The RBA kept its cash rate unchanged at 1.5% in February, as expected.
  • It flagged downgrades to its upcoming GDP growth forecasts and warned that "downside risks have increased".
  • The bank still sees inflation returning "gradually" the midpoint of its target, implying it still believes the next move in the cash rate is likely to be higher, eventually.
  • Financial markets now see the probability of a 25 basis point rate cut by the end of the year at just under 50%.
  • Governor Philip Lowe will deliver his first speech of the year on Wednesday.

The Reserve Bank of Australia (RBA) is growing less confident about Australia's economic outlook, flagging downgrades to its GDP growth forecasts and warning that "downside risks have increased".

"The central scenario is for the Australian economy to grow by around 3% this year and by a little less in 2020 due to slower growth in exports of resources," Governor Philip Lowe said.

"As is the case globally, some downside risks have increased."

Previously, the RBA saw the Australian economy growing by 3.25% this year and 3% in 2020.

However, despite the noticeable deterioration in recent Australian economic data, the bank decided to keep its cash rate unchanged at 1.5% in February, a result that was widely expected by financial markets.

It also pushed back against growing market expectations that it may be forced to cut interest rates again this year, retaining faith that above-trend economic growth will help to gradually lift inflationary pressures in the years ahead.

"Further progress in reducing unemployment and having inflation return to target is expected, although this progress is likely to be gradual," Lowe said.

"Taking account of the available information, the Board judged 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."

While the growth downgrade implies that progress in returning inflation to midpoint of its target may be even more gradual than before, by stating that it still sees that occurring, it suggests it still believes the next move in the cash rate is likely to be higher.

"The central scenario is for underlying inflation to be 2% this year and 2.25% in 2020," Lowe said. That view is similar to that communicated by the bank three months ago. Underlying inflation is likely to return to within its target band, but not the the midpoint over the forecast horizon.

In the year to December, underlying inflation grew by 1.75%. It has undershot the RBA's target for three consecutive years and appears to be decelerating further.

Despite receiving a string of weak indicators on household spending in the second half of last year, Lowe remained optimistic that incomes and consumption levels will improve.

"GDP growth in the September quarter was weaker than expected. This was largely due to slow growth in household consumption and income, although the consumption data have been volatile and subject to revision over recent quarters," he said.

"Growth in household income has been low over recent years, but is expected to pick up and support household spending."

That view reflects that labour market conditions, in his opinion, "remains strong", seemingly an upgrade to the view communicated in December when he said they were "positive".

"A further decline in the unemployment rate to 4.75% is expected over the next couple of years," he said.

"The vacancy rate is high and there are reports of skills shortages in some areas.

"The stronger labour market has led to some pick-up in wages growth, which is a welcome development.

"The improvement in the labour market should see some further lift in wages growth over time, although this is still expected to be a gradual process."

Lowe did not mention the recent decline in ANZ's job ads series, nor the falls in employment seen in recent PMI reports released by the Ai Group.

The expected decline in unemployment mirrors the forecasts previously offered by the bank.

However, despite the belief that stronger labour market conditions will help to lift incomes and household spending in the period ahead, Lowe added a caveat on that view.

"The main domestic uncertainty remains around the outlook for household spending and the effect of falling housing prices in some cities," he said.

Mirroring his assessment on the jobs market, Lowe noted that Australia's growth outlook was being supported by "rising business investment and higher levels of spending on public infrastructure".

There was no mention of the plunge in Australian business conditions in December that fell by the most since the GFC. However, a similar result in January could see Lowe's optimism on business investment begin to ebb.

On the housing market, an area of the economy that has deteriorated noticeably recently, particularly in Australia's southeastern states, Lowe said that Sydney and Melbourne are "going through a period of adjustment, after an earlier large run-up in prices".

"Conditions have weakened further in both markets and rent inflation remains low."

He noted that "credit conditions for some borrowers are tighter than they have been" with credit growth to investors slowing "noticeably" while that to owner-occupiers had "eased".

According to CoreLogic, Australian capital city home prices fell by 1.3% and 1.2% respectively in December and January. The December decline was the largest in percentage terms since 1983. That, along with tighter lending standards, contributed to a steep decline in Australian building approvals and new home sales late last year.

Again, there was no mention of those data points in the condensed policy statement. The bank may have to say in the more expansive meeting minutes.

Global slowdown

Internationally, Lowe acknowledged that global growth slowed in the second half of the year, including in Australia's largest trading partner, China.

"The outlook for global growth remains reasonable, although downside risks have increased. The trade tensions are affecting global trade and some investment decisions," he said.

"Growth in the Chinese economy has continued to slow, with the authorities easing policy while continuing to pay close attention to the risks in the financial sector."

The recent increase in financial market volatility was also mentioned, although Lowe suggested that overall financial conditions "remain accommodative", an outcome partially helped by a shift in policy direction from the US Federal Reserve.

"Market participants no longer expect a further tightening of monetary policy in the United States," he said. "Government bond yields have declined in most countries, including Australia."

So what to make of the RBA's latest offering?

In short, it remains confident, at least publicly, that it will eventually achieve its inflation mandate, an outcome that will likely see it repeat its previous view that the next move in the cash rate will likely be higher, in time.

However, whether that remains the case is questionable given recent signals from some key parts of the Australian economy.

Household consumption looks like it was weak again in the December quarter, as it was three months earlier. Building approvals are falling sharply, and could begin to drag on economic activity earlier than what was expected. There's also plenty of evidence in recent PMI and business confidence reports that suggest momentum across the boarder economy is slowing.

Right now, apart from government investment, commodity revenues and labour market conditions, the signals are not looking all that great.

Given so many of the RBA's forecasts are underpinned by the need for stronger job market conditions, if there's signs that they too are starting to weaken noticeably, the RBA may be forced to question its view that higher rates will eventually be warranted.

We'll hear more from Governor Lowe tomorrow when he delivers his first speech of the year. That will be followed by the RBA's quarterly statement on monetary policy, including fresh economic forecasts, on Friday.

The full February monetary policy statement can be accessed here.