RBA is not likely to lift the cash rate above 2.50% until the March 2016

Macquarie Bank Market Update

All set for a period of stability and interest rate reflection!

The minutes from the Reserve Bank of Australia’s (RBA) June Board meeting reflected a more balanced tone compared to the post meeting statement, which was unreservedly upbeat in terms of the Australian growth outlook. A greater focus on the sustainability of the near-term growth trajectory (with first quarter 2014 (1Q14) gross domestic product (GDP) data coming in well above trend the day following the June Board meeting) and more moderate labour market commentary were features where the minutes were more measured.

The message from the minutes on the labour market is consistent with recent comments from Assistant Governor (Economic) Christopher Kent. While there has been some improvement in forward-looking indicators, these are only consistent with relatively moderate growth in employment in the near term.

It is clear from the minutes that the RBA does not feel that the outlook for inflation is threatened by a lift in wage costs any time soon. The wage price index rose in Q1 at the slowest pace in its 17-year history, and the RBA’s liaison and business survey analysis suggests that wages are likely to remain constrained over the year ahead.

No alarm on the house price front, despite all the chatter

The minutes suggest that the RBA is comfortable with conditions in the housing market. The pace of house price growth appears to be cooling, and supply is coming online. That supply is driving a significant pick-up in residential construction activity, which should filter through to other sectors of the economy over time.

However, business investment remains a soft spot for the outlook. The RBA notes that its liaison suggests that any resurgence in non-mining investment is likely until firms see a sustained improvement in demand. With non-mining firms reluctant to commit to significant new investment, the responsibility for a pick-up in non-mining growth looks to increasingly be landing on consumers.

Moderate employment growth and constrained wage rises do not provide a strong backdrop for consumer spending growth. This is consistent with the expectation of continued below-trend GDP growth, before increasing only gradually in 2015.

The RBA notes that fiscal consolidation is likely to dampen the economy more than expected over the next two years compared to the government’s Mid-Year Economic and Fiscal Outlook (MYEFO), and that beyond that horizon the impact is forecast to be more substantial.

Our interest rate view has changed

We have revised our forecast for the next move in the RBA cash rate and no longer expect the central bank to provide an additional ‘fine-tuning’ rate cut in the September quarter 2014, and anticipate the period of cash rate stability to persist for some time. While significant challenges remain for the outlook for Australia’s economy over the near term, it is increasingly clear that the RBA does not see the need for additional monetary policy accommodation.

In our view, the marginally improved, but still negative Capex expectations data suggest that the risks of a self-reinforcing downturn have reduced somewhat. The improvement in labour market forward indicators points to continued jobs growth, albeit only moderate. The RBA has acknowledged current economic conditions, and has reiterated its comfort with current policy settings.

The early June announcement by the European Central Bank (ECB) of additional policy action has the dual outcome of reducing the risks in the global macroeconomic backdrop, and providing an additional boost to liquidity. If the additional liquidity injection flows through to lower borrowing costs in Australia, then this could have a similar outcome to an additional easing in the official cash rate. This would leave the RBA’s powder dry to respond in the event of a material shock or signs of a significant downturn in domestic conditions.

While we no longer see the need for additional policy support, we have not changed our view that rates are unlikely to rise anytime soon. Indeed, we remain of the view that the RBA is not likely to lift the cash rate above 2.50% until the March quarter 2016.


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