There is a growing risk that RBA will need to make upward adjustments to the GDP growth and inflation forecasts contained in its most recent quarterly Monetary Policy Statement issued in early August. The need for upward adjustments comes from mostly stronger than expected local economic readings since early August plus a lower than expected Australian dollar exchange and higher than expected import prices, especially for energy. Unless there is a dramatic change between now and early November in these factors the next Monetary Policy Statement due on Friday 9th November will need to incorporate upward revisions to near-term GDP growth and inflation forecasts as well as downward revision to the forecast unemployment rate. These changes to the RBA’s forecasts are likely to influence market expectations concerning when the RBA will start to hike its cash rate increasing the probability of an initial hike in the first half of 2019.
The RBA’s economic forecasts contained in the August Monetary Policy Statement indicated annual GDP growth of 3.25% y-o-y for June 2018 extending through to December 2019 before edging down to 3.0% in 2020. The Q2 2019 GDP report was released in early September, a month after the RBA’s forecasts, and was materially stronger than all the RBA’s forecasts out to the end of 2020. The data showed broad-based economic growth generating 3.4% y-o-y GDP change. More importantly from a data-watching viewpoint the monthly readings of July and August retail trade and international trade are hinting at a strong Q3 GDP report due in early December. There is a growing likelihood that Q3 GDP will push further above RBA forecasts and be up 3.5% y-o-y or more.
It is not just the RBA’s GDP growth forecasts that look light-on because of mostly strong data releases over the past two months, the RBA’s unemployment rate forecasts are looking too high as well. The RBA forecast that the unemployment rate would be 5.5% in December 2018 only slowly falling to 5.25% in June 2019 where it would stay for the following year through to June 2020.
When the RBA issued these unemployment rate forecasts it had to hand June 2018 labour force data showing a 5.4% national unemployment rate. The unemployment rate since in both July and August has been 5.3% and on the basis of continuing strong GDP growth in Q3 as well as record high job vacancy numbers in the quarter it is reasonable to expect the unemployment rate to edge lower over the next few months placing it further below the RBA’s 5.5% end of 2018 forecast.
If the unemployment rate is falling more than the RBA previously forecast as seems increasingly likely the pick-up in annual wages growth may prove to be less gradual than the RBA is expecting too. Labour market conditions tightening more quickly than the RBA forecast in August means that RBA’s inflation forecasts could be too low as well.
Importantly it is not just tighter than previously expected labour market conditions that is providing cause to revise the RBA’s inflation forecasts higher, higher import prices and a weaker Australian dollar exchange rate are playing a part too.
In the August RBA economic forecasts, the key technical assumptions for the forecast period were the Australian dollar at $US0.74 and a trade weighted index of 64 and Brent crude oil at $US0.73 a barrel. These technical assumptions have been under pressure since the day they were published. Currently the Australian dollar is trading around $US0.7055 (4.7% lower than the RBA’s assumption), the TWI is 61.2 (4.4% lower) and Brent crude is around $US84.16 a barrel (15.3% higher).
If the exchange rate and oil price changes are sustained they imply stronger than previously expected Australian exports, higher resource sector investment, higher import prices and higher inflation. The substantial changes needed to the technical assumptions alone imply the need for material changes to the RBA’s economic forecasts including its key inflation forecasts.
The Q2 CPI showed Australian annual inflation at 2.1% y-o-y, back inside the RBA’s 2-3% target band. The Q3 CPI is due later in October and the RBA expects annual headline inflation will fall below 2.0% y-o-y and then touch down to 1.75% at the end of 2018 before gradually climbing to 2.25% at the end of 2019. Several administered prices have been reduced causing the temporary dip in forecast inflation. However, it has also become clearer over the past two months that more upward pressure than expected is starting to build on the price of imported goods and services, especially on local petrol prices. The temporary dip in annual inflation could prove to be smaller than the RBA expects, and the bounce upwards afterwards is looking increasingly like being more pronounced.
In early-November, The RBA is likely to need to revise higher its inflation forecasts too presenting a trifecta of upwardly revised GDP growth and inflation forecasts and downwardly revised unemployment rate forecasts. It is a trifecta of forecast changes that the local interest rate market is ill prepared for with its myopic fixation on the softer housing market and expectations of an unchanged RBA cash rate through to 2020.
November may not see the first RBA rate hike but it is likely to see a material change in market expectations of how soon the first rate hike will occur.