The RBA Governor Phillip Lowe is giving a speech at the National Press Club next week, no doubt to recast the RBA’s view on the economy and to present its up-to-date thinking on monetary policy.
This will include whether it still reckons the next move in official interest rates “is likely to be up”.
I don’t know what Dr Lowe will say or how the view of the RBA has changed since it last went public with its upbeat views on the economy in early December, but if I were RBA Governor, this is what I would say:
The economy has not performed as we were expecting.
This is not to say that the economy is entering a period of trouble, far from it. But the economy is falling short of the optimistic outlook the RBA held for the bulk of the last year.
“The economy has not performed as we were expecting.”
The main areas of surprise are related to the housing downturn, both in terms of house prices and new construction, and the flow through of these trends to household consumption spending.
In addition to weaker than forecast GDP growth in the September quarter, the severity of the housing downturn is forecast to reduce GDP growth in 2019 and 2020. The downward revision to the forecast for household consumption growth is not being offset by unexpected strength elsewhere, hence the material change to the Bank’s overall growth outlook.
This downward revision to growth has in turn seen the Bank’s forecasts for inflation revised lower from what was an already low starting point. On current monetary policy settings, inflation will not return to the mid-point of the target until beyond the current forecast horizon through to the end of 2021.
Given the role the inflation target has played for 25 years in helping to maintain inflation expectations and as a result support growth, this is not a desirable outcome. There is evidence that the persistence of low inflation is feeding into yet lower inflation expectations.
RBA staff also spent the summer period reworking our estimates of trend GDP growth and NAIRU. While these estimates will always be imprecise and subject to debate and revision, our prior estimates for trend annual GDP at 2.75 per cent with NAIRU around 5 per cent have proven to be obsolete.
The updated estimates, which will appear in the Statement of Monetary Policy to be released later this week, are 3 per cent for annual GDP growth and under 4.5 per cent for the unemployment rate. At one level, these are not big revisions.
On another, and given the flow of economic news in recent months, it means again that current policy settings will not see these sorts of results for the economy; that is, sustained 3 per cent GDP growth and a 4.5 per cent unemployment rate.
As has been well documented on many occasions, there are limitations to the extent to which monetary policy can target economic growth and the unemployment rate. But given the degree of slack in the economy and some of the risks for yet slower growth and a stalling in the progress in reducing unemployment as well as the risk of additional downside inflation pressures, easier monetary policy is now likely in the months ahead.
“Earlier expectations of a pick up in inflation have fallen short with inflation forecasts from the major central banks being revised lower in recent months.”
Adding to the information that necessitated this change of view has been information from the global economy which is undergoing a transition towards slower growth. Earlier expectations of a pick up in inflation have also fallen short with inflation forecasts from the major central banks being revised lower in recent months.
Of importance, the deceleration in global growth from the position around the middle of 2018 is broadly based.
China is transitioning to a period of moderate expansion, while earlier encouraging signs of a pick up in the Eurozone and Japan have faded. Financial markets have both the Bank of Japan and European Central Bank retaining the current monetary policy stance over the medium term.
The US economy is moderating. A combination of the prior monetary policy tightening from the Federal Reserve and the passing of the impact of the earlier fiscal stimulus are contributing to growth decelerating. Such are the recent trends that financial markets are scaling back pricing for further monetary tightening from the Fed.
The change in our assessment of economic conditions is, as is always the case, subject to revision as data and events emerge.
The RBA are pragmatic and open to the obvious fact that if or when the economy does not pan out as forecast, we change our forecasts and with that, our policy biases and actions.
Which brings us to now.
The case for a lowering in the official cash rate is gaining strength. Lower official interest rates are likely in coming months.
Easier monetary policy will, in time, see the economy return to sustained trend economic growth and lower unemployment. Allowing for the normal lags, wages growth will continue to pick up and inflation will return to the target range, but not before the second half of 2020.
In the unlikely event that inflation accelerates in the near term, to a rate heading towards the top end of our 2 to 3 per cent band, we would, of course, reverse the monetary stimulus.
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