What the RBA should have said and done today
At its meeting today, the Board decided to reduce the cash rate by 50 basis points to 1.00 per cent.
While conditions in the global economy are continuing to improve uncertainties remain. Growth in the Chinese economy has picked up a little and is being supported by increased spending on infrastructure and property construction, but the high level of debt continuing to present a medium-term risk. In the US and Europe, GDP is growing at a trend pace, but wages growth remains low and there is considerable slack in labour markets.
Commodity prices have generally risen recently, although Australia’s terms of trade are still expected to decline over the period ahead.
Core inflation remains subdued in most countries and is expected to remain low over the medium term. Headline inflation rates have declined recently, largely reflecting the earlier decline in oil prices. In the United States, the Federal Reserve expects to increase interest rates further and there is no longer an expectation of additional monetary easing in other major economies, although a withdrawal of the current monetary policy stimulus is unlikely in the near term. Financial markets have been functioning effectively and volatility remains low.
The Bank’s forecasts for the Australian economy point to ongoing below-trend growth, around 2.5 per cent. The transition to lower levels of mining investment following the mining investment boom is almost complete, with some large LNG projects now close to completion which means the drag on growth is likely to ease. Business conditions have improved and capacity utilisation has increased. Some pick-up in non-mining business investment is expected, albeit from a low base. The current high level of residential construction is forecast to gradually ease over the remainder of 2017 and into 2018 and will subtract from growth next year. One ongoing source of uncertainty for the domestic economy is the outlook for household consumption. Retail sales have picked up recently, but slow growth in real wages and high levels of household debt are likely to constrain growth in spending. Growth in household spending is expected to be moderte over the forecast horizon.
Employment growth has been stronger than expected over recent months and the various forward-looking indicators point to continued growth in employment over the period ahead. The unemployment rate is remains elevated and near record high underemployment suggests there is substantial spare capacity in the labour market. As a result, wage growth is forecast to remain low and provide an important factor dampening inflation.
The recent inflation data confirmed both CPI inflation and measures of underlying inflation are running under 2 per cent which was not expected last year when cash rate was cut to 1.5 per cent. This is a vital issue in the decision to lower the cash rate. While inflation is expected to pick up gradually into 2018, it is forecast to remain below the middle of the target band. Higher prices for electricity and tobacco are expected to boost headline CPI inflation, but will not materially impact on underlying inflation. These price rises are forecast to undermine household spending in the second half of 2017. A factor working to lower both headline and underlying inflation is increased competition from new entrants in the retail industry.
The Australian dollar has appreciated recently, partly reflecting a lower US dollar. The higher exchange rate is expected to contribute to subdued price pressures in the economy. It is also weighing on the outlook for output and employment. An appreciating exchange rate would be expected to result in a slower pick-up in economic activity and inflation than currently forecast.
Conditions in the housing market vary considerably around the country. Housing prices have been flat or falling in around one-third of Australia. There is tentative evidence of financial stress in these areas. Prices have been rising briskly in some other markets, although there are some signs that these conditions are starting to ease. In the eastern capital cities, a considerable additional supply of apartments is scheduled to come on stream over the next couple of years which will work to dampen prices. Rent increases remain low in most cities. Investors in residential property are facing higher interest rates from the banks and other financial intermediaries. There has also been some tightening of credit conditions following recent supervisory measures to address the risks associated with high and rising levels of household indebtedness.
The Board judged that lower interest rates were needed to support the Australian economy. Taking account of the available information, the Board judged that a 50 basis point cut at this meeting would help to lift growth in the economy, dampen demand for the Australian dollar and would be consistent with achieving the inflation target over time.