For a more comprehensive round up of the week, listen to Stephen’s full report here.

Since mid-April we have adjusted our view twice about how the RBA will change the cash rate over the next 12 months or so, but it unlikely we will make further changes over the next few months. The first change to our rate view occurred after the lower-than-expected Q1 CPI release in late April. Prior to the CPI release we had expected a third consecutive high-side quarterly inflation report which when combined with evidence of rapidly reviving household spending would have led most likely to the RBA hiking the cash rate in August, just after the Q2 CPI report which we also expected to be quite high. The lower-than-expected Q1 CPI report was in late April sufficient for us to make the first change to our cash rate forecasts – to delay the start of the rate hiking cycle probably by three months until November, shortly after the Q3 CPI release in Late October.

By mid-May, we needed to consider further fine-tuning of our cash rate view. The May Federal Budget was always likely to introduce changes that would present some headwind to prospective economic growth. The order of headwind was not unduly big, about 0.3 percentage points of GDP growth in 2014-15 extending to 0.4 percentage points in 2015-16 and 2016-17, but the composition of the proposed spending cuts and tax changes seems to have evoked a negative sentiment reaction among consumers well in excess of what would seem warranted by the budget changes.

The monthly consumer sentiment reading from the Westpac-Melbourne Institute’s survey showed a particularly sharp fall immediately post-budget by 6.8% to an index reading of 92.9 well below long-term average. The component questions relating to family finances now compared with 12 months and looking ahead 12 months were particularly weak registering respectively falls of 11% and 23%, the latter fall by far the biggest in one month in the entire history of the survey dating back to 1974.

One month on from the post-budget consumer sentiment survey and it was very important that there should be some bounce in sentiment to reflect a degree of initial over-reaction to proposed budget changes. The bounce was tiny in the overall sentiment reading, up only 0.2%, and the family finance questions continued to make disturbing reading, with the response on current finances down a further 5.4% and future finances up 5.0% but clawing back less than a quarter of the big decline in the May survey.

Even though sentiment indicators do not provide hard evidence about the economy, they assume rather more importance currently when a pronounced rebalancing in local economic growth drivers is needed if the economy is to grow near long-term trend over the next year or so providing an environment allowing the unemployment rate to slowly decline. The behavior of the household sector will be crucial to how well the economy rebalances to offset the known approaching slack from declining mining investment spending as well as more cautious government spending.

If household are to continue to spend more on housing and are to consume more, they will need to save a smaller proportion of their income than they have been in the years since the global financial crisis. There is no real possibility that growth in household income will be sufficiently strong to drive stronger spending keeping in mind that wages are growing at the slowest annual pace in at least 15 years, at 2.6% y-o-y, set against the latest annual CPI reading of 2.9% y-o-y. Real wages, after allowing for inflation, are taking a very rare step backwards.

Households need to be more confident, not less, if they are to start reducing the proportion of their income that they save and devote a greater proportion of their income to spending. The hard economic evidence relating to monthly housing finance commitments and retail sales is that the beginning of Q2 is exhibiting less strong growth than all of Q1. Combine decelerating growth in household spending with evidence that by far the strongest part of the economy, exports, are not as strong as they were in Q1 as well and it seems to us that barring some exceptionally high inflation pressure the RBA is likely to see reason to leave very accommodating monetary policy in place for longer.

Our second revision in in our cash rate outlook occurred in late May and we changed the date of the first monetary policy hike from November 2014 to March 2015. We see slowly improving global economic growth and very low local interest rates combining to restore better Australian economic growth readings in Q3 and Q4 2014 after a soft Q2 GDP report (due early September). Inflation readings are likely to be relatively high in our view with annual inflation around 3% to 3.3% over the next three quarterly readings. Eventually, we see the RBA recognizing that it is no longer prudent to leave the cash rate at an exceptionally low 2.50% and will work to restore a more neutral monetary policy setting consistent with a cash rate around 3.25%.

In detail, our cash rate view is a first 25bp cash rate hike to 2.75% in March 2015, followed by two more hikes taking the cash rate to 3.25% by the end of June 2015. Beyond June 2015 we see another period of relatively protracted interest rate stability last until at least the end of 2015. As always, we will change our interest rate view if we see need to change our growth and inflation forecasts, but at this point it is unlikely there will be sufficient new information to warrant a change to our economic forecasts over the next few months. Equally we can say with some confidence that it is unlikely over the next few months that the RBA will be changing its 2.50% cash rate.