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Economic and Financial Market Update: Tomorrow Is A Better Day

boq economic update feb 2018

9/02/2018

Summary:

  • The economy shifted up a gear in 2017;
  • But inflation remains low;
  • The economy needs to stay strong to create more full-time jobs;
  • Financial markets are pricing the cash rate to remain at 1.5% for the next 6-9 months.

And maybe tomorrow is a better day
I know tomorrow is a better day

‘Maybe Tomorrow is a Better Day’

Poets of the Fall

The words from the Finnish band ‘Poets of the Fall’ summed up the current sentiment about the economic outlook:  tomorrow looks likely to be a better day. Momentum in the global and domestic economy is improving resulting in plenty of analysts revising up their economic forecasts. The RBA in its Monetary Policy Statement broadly kept their economic forecasts unchanged, only modestly revising down their view on the unemployment rate. But their confidence about the outlook has clearly improved.

RBA economic forecasts

Variable Forecasts for Dec 18 Forecasts for Dec 19
Nov 17 Report Feb 18 Report Nov 17 Report Feb 18 Report
GDP 3.25% 3.25% 3.25% 3.25%
Unemployment rate 5.5% 5.25% 5.25% 5.25%
Headline CPI 2.25% 2.25% 2.25% 2.25%
Underlying CPI 1.75% 1.75% 2% 2%

Sources:  RBA November 2017 and February quarterly Statement on Monetary Policy.

The most obvious sign that the economy is doing well was the very strong jobs growth last year. There were over 400,000 new jobs created, the fastest pace of growth since the GFC. While the unemployment rate only declined modestly in 2017, all the extra jobs lured workers back into the market. The participation rate has moved up to currently be near a record high. A growing number of firms are indicating that labour is starting to become a constraint, while the proportion of firms indicating that a lack of orders is a problem is the lowest since the GFC.

boq economic update feb 2018boq economic update feb 2018

So the economy has clearly shifted up a gear over the last year. But the RBA has provided signals that it is no rush to change interest rates. Despite all the new jobs, the high underutilisation rate indicates that there are still plenty of people on the look-out for a full-time job. The recent CPI number highlighted that inflation remains too low. And there is a good chance that inflation might remain low given that firms expect to keep any price rise modest. Right now firms are more concerned when setting prices about the impact of strong competition than the benefits of a strengthening economy. Price rises are particularly difficult to achieve for retailers given that consumers are being weighed down by soft disposable income growth. The softness of consumer spending is one of the key domestic economic risks.

boq economic update feb 2018boq economic update feb 2018

Another factor keeping the RBA quiet is that the AUD remains relatively high by historical standards. There are good reasons the AUD has been strong. Commodity prices (a key driver of the AUD) are relatively high. And the current account deficit is relatively low. The high value of the AUD is keeping inflation contained, and therefore doing some of the work of higher interest rates. Add that regulatory changes are helping to mute credit and house price growth and it is easy to see why the RBA is happy for now to stay on the sidelines and see how the economy develops.

One thing that is unlikely to influence RBA views is the recent equity market volatility (a point made in a speech by Governor Lowe). Despite the recent decline, the value of the US sharemarket is comfortably higher than this time last year. It would take a substantially greater fall in sharemarkets before views on the economic outlook would need to change.

boq economic update feb 2018boq economic update feb 2018

The bottom line is the economy is strengthening but there remains room for the economy still to grow without inflation becoming an issue. One implication is that very few analysts (one) expect rate cuts any time in the foreseeable future. And the current low level of inflation means few are expecting any rate change in the first half of 2018. But the strength of the economy means the majority of analysts are forecasting the domestic cash rate to be higher by year-end (although 1.5% remains the most popular forecast). And if the economic growth continues in line with most expectations, a large number of analysts think the cash rate will be half percentage point higher by mid next year.

boq economic update feb 2018

So events in Australia are following the global story where better economic times will lead to higher interest rates. The comments by the RBA suggest that they are in no hurry to pull the rate trigger. It seems a case of following the advice of that well-known economics commentator, the Roman Emperor Augustus, to, “Hasten slowly.”

We live in interesting times.

This blog post is for general information purposes only and is not intended as financial or professional advice. It has not been prepared with reference to the financial circumstances of any particular person or business and should not be relied on as such. You should seek your own independent financial, legal and taxation advice before making any decision about any action in relation to the material in this article.

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