Several economic events and readings turned out differently over the past week from the way we expected. The RBA left the cash rate unchanged at 2.00%, rather than cutting by 25bps as we expected. In their more detailed economic assessment later in the week the RBA trimmed their growth forecasts less than we thought likely and were generally more upbeat than we thought likely. On the economic data front, retail sales were stronger than we expected in June, up by 0.7% and were also stronger than expected in real terms Q2, up by 0.8% against our forecast of 0.3%. Employment was also stronger than expected again in July, up by 38,500. All told, it seems that the RBA is likely to hold the cash rate at 2.00% for the next month or two at least although we still the run of data being soft enough over the next few months to warrant a cash rate cut, probably in November.

The RBA’s economic view that Australian growth will gradually improve to around 3% over the next two years is contingent on a number of factors. The first is that around trend global growth experienced over recent years continues. Within the RBA’s global growth view is acceptance that in the United States the Federal Reserve will start lifting its funds rate from zero later this year. Even when the funds rate starts to rise the US monetary policy setting should still effectively be growth accommodating for some time. In practice it will be interesting to see how growth fares in the US as interest rates start to rise.

Also relating to the RBA’s global growth view, the RBA sees growth in China basing around 7%, the official target, and responding to the extensive policy easing measures implemented since late 2014. The RBA sees the ructions in China’s sharemarket as being unlikely to have a noticeable negative influence on consumer spending. The RBA admits to uncertainty surrounding how growth will pan out in China. Already, the first few July data releases from China relating to exports and imports hint at growth on the soft side of the RBA’s China view.

As far as the Australian economy is concerned the RBA sees conditions slowly improving on a quite broad front. Even if businesses are still reluctant to invest, they are responding more optimistically to surveys about business conditions and expectations, are enjoying better profit growth and are employing more people. Household spending is rising but funded by a drift down in household savings with wages growth still unusually low. The RBA expects household spending to continue to improve over the next two years assisted by very low interest rates – an admission by the RBA that very low interest rates need to persist if household spending is to lift as needed to sustain growth.

The RBA remarks that the depreciation of the Australian is helping to promote exports of services in particular a source of some strength for economic activity. At the same time the depreciation of the Australian dollar is also adding a touch of upward pressure to the inflation outlook although the RBA still expects inflation to stay within 2-3% target band over the next two years.

Gradual improvement is the way the RBA is reading both the global and local economic outlook. What is perhaps clearest in the RBA’s statement is that it wants gradual improvement to continue unimpeded. There is still excess capacity in the Australian economy. While an unemployment rate stabilizing somewhere near 6% is encouraging it could be a lot better without placing untoward upward pressure on inflation. It is very unlikely that the RBA will be thinking about lifting the cash rate above 2.00% any time over the next year or so.

Instead, the main issue remains what policy action will be taken if the “gradual improvement” view starts to slip. We still see a high probability that economic releases over the next few months will mostly sit on the softer side of what is needed to support the RBA’s “gradual improvement” view. We tentatively pencil in a 25bps cash rate cut to 1.75% at the RBA’s November policy meeting and then see that rate holding for at least 12 months beyond.