The RBA Board minutes confirmed the current neutral policy bias. Of most interest was the commentary on the importance of house prices for its forecasts.
The minutes of the Reserve Bank Board meeting for February have largely confirmed the themes which were set out in the February Statement on Monetary Policy.
Key to these themes is “the probabilities around these scenarios were now more evenly balanced than they had been over the preceding year when an eventual increase in the cash rate had appeared more likely”. Of course, the two scenarios relate to an eventual increase and an eventual decrease in the cash rate.
The policy outlook is firmly linked to progress in reducing the unemployment rate and moving the inflation rate back into the 2-3% policy band.
The risks around the outlook centre on the household sector and dwelling investment. The Bank remains generally comfortable with the outlook for business investment ; government spending and external conditions.
Clearly, developments in the housing market, particularly in Sydney and Melbourne, are attracting considerably more attention than we had seen in the minutes of meetings held in 2018. In particular, the Bank’s current position that the effect of recent price falls on overall economic activity was expected to be relatively small is noted. However, in a very significant warning around the policy outlook, the minutes state “if prices were to fall much further, consumption could be weaker than forecast, which would result in lower GDP growth, higher unemployment and lower inflation than forecast”. This statement directly links developments in house prices to the Bank’s key policy forecasts. The causal mechanism would be around a larger wealth effect than currently expected impacting consumer spending, and a sharper downturn in residential building activity than has been recognised, even in the Bank’s new much more subdued forecasts relative to the November Statement on Monetary Policy.
Note that for the record, the RBA’s GDP growth is forecast at 3 per cent in 2019 and 2.75 per cent in 2020. These forecasts are down from 3 ¼ per cent in 2019, and 3 per cent in 2020. The downward revisions are largely attributed to softer consumption growth and a sharper downturn in dwelling investment.
Westpac has long argued that the RBA’s previous growth forecasts were too high, and indeed, our current forecasts for 2019 and 2020 of 2.6% are still below the RBA’s numbers.
The RBA’s handle on the outlook for housing prices in Sydney and Melbourne appears tenuous. The minutes note that the recent falls “were relatively large by historical standards, and that it was unusual for housing prices to fall significantly in an environment of low mortgage interest rates and a declining unemployment rate”. Note that in previous periods of falling house prices, large interest rate cuts have followed, and were successful in stabilising the markets. The current period of low mortgage rates means that the usual policy response to stabilise markets with large rate cuts will not be possible, and it is therefore not unreasonable to expect that further falls in house prices may occur. Based on the comments in these minutes, such an outcome is likely to lead to further downward revisions in the RBA’s forecasts.
Conclusion
The minutes note that financial market pricing implied that the Australian cash rate was expected to remain unchanged for a considerable period with some expectation of a decrease by late 2019.
Over most of last year when markets; the RBA, and most economists were forecasting higher rates, Westpac’s view was consistently that rates would remain on hold in 2019 and 2020. That was largely because our growth, inflation and employment forecasts did not justify higher rates. As discussed, our current forecasts remain lower than those of the RBA and we therefore expect that, over time, the RBA will further revise down their forecasts.
However we do not think that those downward revisions will be sufficient to trigger a rate cut. As usual, our forecasts will continue to be reviewed.
