The minutes of the November monetary policy meeting of the Reserve Bank Board confirm the confident approach we have seen in the recent Statement on Monetary Policy.
While consumption growth is still identified as a source of uncertainty, the Board expects it to remain around the 3% level over the next few years that we have seen recently. Household disposable income growth is also forecast to increase at that rate.
GDP growth and labour market conditions had been stronger than the Bank had expected over the last twelve months. Accordingly, the forecast for the unemployment rate had been lowered to 4 ¾ per cent from 5 per cent by mid-2020, with an implied downside risk to that forecast. With the improved labour market outlook, there has been a modest upward revision to the outlook for wages growth. This is a particular encouraging development for the Bank as they see wages growth as the key uncertainty for future consumption growth and inflation.
In that regard, the forecast for inflation has been lifted modestly, reflecting the brighter outlook for economic activity, the labour market and wages.
Despite a disappointing capex survey, non-mining business investment was expected to continue to make a significant contribution to output growth supported by above average business conditions and the significant pipeline of non-residential construction work.
Their discussion around the housing market is a little less confident. Residential building approvals are recognised to have fallen in the September quarter and liaison with builders paints a difficult picture. Furthermore, it is noted that housing prices have fallen further in Sydney and Melbourne, although are stable in most other cities. With the Bank’s core forecast that consumption and income growth will be aligned, there is no allowance for any negative wealth effects from these housing developments. The minutes discuss the various policy stances of other central banks noting that “market pricing was consistent with policy rates remaining steady over the following year in Australia and New Zealand, where policy rates had not been lowered to the extent they had in some other economies”.
The Board also discussed the Bank’s forecasting performance over the previous year, noting that forecast errors were smaller than historical averages with GDP growth and business investment surprising to the upside, the terms of trade average being higher than expected, and the marked depreciation in the Australian Dollar. Labour market outcomes were also stronger than expected, although wages growth and inflation had evolved largely as expected. This assessment supports the gradualist policy approach supported by growth holding above potential with associated declining spare capacity leading to a gradual increase in wages growth and inflation.
There is also a rather curious discussion around arguments that had been advanced by various commentators. The arguments are set out but they make no qualitative assessment of their reliability.
We know that the Governor has noted that interest rates could be cut in the event of a global shock and it is interesting that the minutes point out that the monetary policy response to that shock would depend on the associated move in the exchange rate.
The final section of the minutes once again emphasises the importance of wages growth. It is noted that there has been a noticeable pick-up in wages growth in most advanced economies, and Australia requires “a gradual increase in wages growth for inflation to be sustainably within the target range”.
As in the section of the minutes on the domestic economy, the concluding section leaves the discussion around housing markets somewhat up in the air. Credit conditions are recognised as being tighter than they had been for some time, but lending rates remain low and there was strong competition for borrowers of high quality.
In the final paragraph in the minutes, the Board emphasises that “there was no strong case for a near-term adjustment in monetary policy”, although the comment “since progress on unemployment and inflation was likely to be gradual” which featured in the October minutes was not used in these minutes. Based on the confident assessment in the body of the minutes, it is possible that the Board is a little more confident with its view that the next move in the cash rate will be an increase.
Conclusion
This is a balanced set of minutes but does indicate more confidence from the Board around its growth, employment, wages and inflation views. The outlook was also boosted by the expectation that consumption and income growth will hold at 3% despite slowing employment growth, and risks around the housing market in Sydney and Melbourne.
By noting that market pricing is not expecting a policy adjustment for the next year, the Bank does appear to be extremely patient with its next policy move. Westpac expects that their growth forecast for 3 ¼ per cent growth in 2019 is too high, mainly because of an expected downturn in residential construction, a slowdown in consumption growth associated with weaker income growth and some wealth effects. That development alone is likely to take the edge off the expectation of rising wages and higher inflation.
We retain our view that the cash rate will remain on hold in 2019 and 2020.
