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We are pushing out our forecast of the first 25bp cash rate hike by the RBA to November 2015 from March 2015. We make the change taking account of the weaker than expected July labour force report and the changes to the RBA’s economic forecasts contained in its Monetary Policy Statement released last Friday.

A single monthly labour force reading is insufficient usually to warrant a significant change to economic forecasts. The July labour force report, however, confirms a distinctly weaker change in employment growth not just in the month, but over the past few months. Employment unexpectedly fell by 300 in the month of July, but in the three months ending July, it rose by only 9,800. In contrast, the labour force – those in work plus those actively seeking work – rose by 80,300 in the three months ending July resulting in the number of people unemployed rising by 70,500 over the same period taking the unemployment rate up from 5.8% in April to 12-year high of 6.4% in July.

In contrast, in the previous three month period between January and April 2014, employment rose by 79,000; the labour force rose by 67,800; those out of work fell by 11,200 and the unemployment rate came down to 5.8% from 6.0% in January. Clearly, labour market conditions have worsened materially in the April to June period compared with the January to April period and have worsened to the point where the unemployment rate is rising. The weakness in the labour market also implies that unusually low annual growth in wages – only 2.6% y-o-y in both Q4 2013 and Q1 2014 and below the annual CPI increase in both quarters – will persist for some time making it hard to prime a sufficiently strong lift in household spending to help rebalance the economy as mining investment spending continues to fall away.

The latest economic forecasts by the RBA published in its quarterly Monetary Policy Statement recognise the dour labour market performance and outlook. The RBA has reduced its GDP and CPI annual change forecasts roughly quarter of a percentage point going out through 2016. The RBA is now forecasting sub-trend annual GDP growth persisting through much of 2015. Inflation, both on headline CPI basis and underlying basis is now forecast by the RBA to fall to 1.75% to 2.75% range by the middle of 2015 and roughly stay inside 2-3% target band (on underlying basis) through to the end of 2016. Importantly, the softness of the labour market combined with very weak wages growth makes it hard for anyone to argue convincingly for a stronger economic outlook than the RBA is forecasting.

The RBA’s latest growth and inflation forecasts imply that even though the very accommodating 2.50% cash rate has been in place now for an unusually long 13 month period, there is a strong likelihood that the low rate could be in place for at least as long again. Although the cash rate has been stable for a long time borrowing interest rates and interest rates available to depositors have drifted lower and this trend is likely to continue constituting a further ‘de facto’ easing of monetary policy over coming months, even with no change in the cash rate.
It is this ‘de facto’ further policy easing, plus a stronger likelihood of a depreciating Australian dollar that will probably work, together with slowly improving global economic growth, to lift Australian GDP growth and arrest labour market weakness through 2015. This ‘de facto’ policy easing is also the main reason why the RBA is unlikely to consider cutting the cash rate.

By late 2015, we see economic conditions improving enough to make the RBA a little more wary about the inflation outlook in 2016 and 2017 as well as wanting to reverse the additional easing in ‘de facto’ borrowing and deposit rates that may have occurred in the previous 12 months. The Q4 2015 monetary policy statement, due the first Friday of November 2015 could well prove to be the time when the RBA lifts its growth and inflation forecasts if our view is accurate. It also implies a first 25bp rate hike just ahead of the release of the monetary policy statement.

Forecasting what may happen over the next 12 months and more is always subject to high degree of uncertainty. What is much more certain is that there is little over the next few months capable of presenting a case strong enough for the RBA to hike interest rates, but there is plenty to suggest that the RBA should leave the cash rate unchanged at 2.50%.