The Australian economy is in a happy place where growth and inflation will accelerate gradually over the next year or two and there is little pressure on the RBA to change its 1.50% official cash rate. Indeed, holding the cash rate low and steady over the past two years has contributed to placing the economy in a slowly improving phase. These are the essential messages contained in the various economic commentaries from the RBA over the past week including the Governor’s Statement accompanying the rate decision (no change again); a speech from RBA Governor Philip Lowe and the quarterly Monetary Policy Statement. Our view is that the economy is currently in a happy place as the RBA says. Where our view differs from that of the RBA is that we expect more pace in the year ahead in GDP growth lift; falling unemployment rate; and rising inflation.
It is possible that both the RBA and we are too optimistic about Australian economic growth prospects. The risk factors that might lead to a weaker-than-expected Australian growth outlook include a deeper and more prolonged housing downturn than expected currently; faltering growth in spending by the highly indebted household sector beset by prolonged slow wages growth; or an international shock precipitated by worsening international trading conditions.
Each of these factors has the potential to limit Australian growth prospects, but currently each is not unduly threatening. The downturn in Australian housing activity is patchy and modest so far and is even generating some positive economic outcomes rebalancing home-buying in favour of owner-occupiers rather than investors and improving home lending standards assisting financial stability.
The household sector appears to be coping with its high debt load relatively well and a modest lift in the pace of wages growth in 2018 so far (a six-year high lift in growth in the wages bill when employment growth is added to the total) is driving a lift in household spending. Sentiment surveys are pointing to an even stronger improvement in household consumption spending later this year.
The potential downside risks to global growth from rising trade tensions are real but are occurring when upward growth momentum in the global economy is strong. US above-trend growth is well supported by strong growth in US corporate and household incomes. Stronger government spending is contributing too. In China, the authorities have loosened monetary policy and added to official spending to boost growth. It is hard to be pessimistic about global growth prospects when the two biggest economies are likely to progress close to full-steam ahead.
The slower-than-expected Australian economic growth adherents could turn out to be right, but they would appear to be backing a very low chance. By far the most likely prospects for the Australian economy are along the lines of the RBA’s forecasts of slow pick-up in growth and inflation or our forecasts of speedier pick up in both.
One element in the RBA’s low annual inflation forecast path where annual inflation falls to 1.75% by end-2018 before gradually lifting to 2.25% in 2020 is that administered prices – the likes of gas and electricity prices, TAFE fees and child care costs, will deliver a “one-time” reduction to the annual inflation rate in Q3 2018. Other suppressants of inflation include high levels of price competition in the retail sector and slow lift in wages. It is also worth noting the technical assumptions in the RBA’s forecasts over the next two and a half years – the Australian dollar at $US0.74, trade weighted index 64 and crude oil at $US73 a barrel.
Our higher inflation forecasts allow that “one-time” price influences are not all on the downside. Food prices will rise with the extensive drought in NSW and Queensland. The changes to education funding while lowering TAFE fees are likely to add to primary and secondary school fees early next year.
We see wages growth accelerating relatively soon based on wage claims flowing from and based off the 3.5% lift in minimum wages earlier this year. Fast employment growth is starting to highlight skill shortages in industry sectors such as education, health services and construction, a pressure point for higher wages. Public sector wage claims are showing signs of acceleration too.
The technical assumptions underpinning the RBA’s forecasts may turn out to be inaccurate and less consistent with low inflation. The Australian dollar is trading below $US0.73 this morning and around 63 on trade weighted basis, already down around 1.5% on the RBA’s technical assumptions published last Friday! More importantly, the Australian dollar may come under pressure to depreciate further if the RBA leaves the cash rate unchanged at 1.50% for several more months while the US Federal Reserve continues to lift its Funds rate.
The RBA’s oil price assumption also looks too low as the improving global economy lifts demand for oil while the escalating political disturbances in the Middle East threaten periodic reductions to oil supply.
If our higher/sooner economic growth/inflation forecasts turn out to be closer to the mark than those of the RBA an issue is when will the RBA lift its forecasts of growth and inflation? We suspect that the RBA will want to see the proof in at least three to six months of data and that implies that our forecast of a first cash rate hike in November is too soon and that early next year is more likely. We now see a first cash rate hike of 25bps to 1.75% occurring in February 2019. The conditions leading the RBA to hike in February (faster than previously forecast growth and inflation) also imply that a series of rate hikes will be necessary taking the cash rate to 2.25% by the end of 2019.