The RBA has lowered their growth forecasts but they remain above that of Westpac. The Governor chose to repeat the statement’s concluding paragraph which explains the policy decision with the same words that he used in December despite lower forecasts and recognition of downside risks.
As expected, the Board of the Reserve Bank decided to leave the cash rate unchanged at 1.5%. At the February meeting, the Board discusses the executive’s revised forecasts which will be released in the February Statement of Monetary Policy on February 8. However, in recent statements, the Governor has provided readers with growth and inflation forecasts and this was repeated in today’s statement. For 2019, forecast growth has been revised down from 3 ¼ per cent to 3 per cent, and 2020, from 3 per cent to “a little less” due to slower growth in exports of resources. It is important that this 3 per cent growth forecast is above the assessed trend rate of 2 ¾ per cent, and the implied 2020 forecast is likely to be around trend. If a central bank is forecasting above trend growth, then it is highly unlikely to adopt an easing bias, and indeed the chances are still likely that the Governor will persist with his assessment that even though rates are likely to remain steady for some time, the next move is likely to be up.
The inflation forecasts were also revised with the underlying inflation forecast for 2019 reduced from 2 ¼ per cent to 2 per cent, while the 2020 forecast remains at 2 ¼ per cent. Hence the Bank is maintaining the view that inflation will gradually move into the 2 to 3 per cent band, although it will take somewhat longer than previously expected.
There are good reasons why the Bank lowered its growth forecasts. Firstly, while it still assesses the outlook for global growth as “reasonable”, it recognises that “downside risks have increased”. Secondly, it has made some significant changes around the household sector and housing. For some time, Westpac has argued that the fall in house prices in Sydney and Melbourne will be associated with a negative wealth effect. In the RBA’s previous writings, they tended to dismiss any wealth effect, but in today’s statement the Governor notes “the main domestic uncertainty remains around the outlook for household spending and the effect of falling housing prices in some cities”. In linking house prices with household spending, he appears to be recognising the risk of a negative wealth effect.
Westpac has also argued that residential housing construction will be a drag on growth in both 2019 and 2020. The RBA has not supported that view, referring to a strong pipeline. But, recent falls in dwelling approvals, including for detached housing, clearly point to a significant drag on growth from the housing construction downturn.
The statement continues to point to “rising business investment” which in the December statement was linked to “business conditions are positive”. The Governor has obviously decided that the strong negative signal from the recent NAB business survey was insufficient at this stage to review the business investment outlook. Given that the survey was taken in early January, Westpac thinks that approach is reasonable but there will be considerable interest to see whether future surveys send a more positive signal.
The Governor maintains his positive rhetoric around the labour market and confirms its forecast that the unemployment rate will fall to 4 ¾ per cent by the end of 2020. He also expects a further lift in wages over time, supporting household incomes.
Financial conditions in the US attract some attention, although the recent sharp decline in equity prices is noted to have been partly reversed. He also observes that market participants no longer expect the FOMC to be tightening monetary policy. The Sydney and Melbourne housing markets are assessed as “going through a period of adjustment”, and credit conditions have tightened. This is the approach which he has taken in previous statements but it is very significant that he has begun to recognise a potential wealth effect, meaning that the price adjustment may have implications for the real economy.
With a more cautious view on the wealth effect and recognition that dwelling construction will contract, Westpac’s GDP forecast for 2019 and 2020 is 2.6%, with recent data releases pointing to downside risks even for those modest numbers.
Finally, the Governor chose to repeat the concluding paragraph which explains the policy decision with the same words that he used in December despite lower forecasts and recognition of downside risks. Notably, it includes the sentence “Further progress in reducing unemployment and having inflation return to target is expected, although this progress is likely to be gradual.”
Conclusion
With these revised forecasts, the RBA is clearly less comfortable with its previous positive outlook. Its growth forecasts remain significantly above Westpac’s own view. With our forecasts of 2.6% growth in 2019 and 2020, it still seems that the more likely outcome will be for steady rates, even if as we expect, the RBA will eventually have to adopt growth forecasts much closer to Westpac’s current view. Westpac confirms its long-held forecast that the RBA cash rate will remain on hold in 2019 and 2020.
