- The RBA again kept the cash rate unchanged at 1.5%;
- The RBA view that the economy is strengthening, and will (in time) lead to higher inflation, remains unchanged;
- The strength of the currency remains an issue;
- The inflation data (released 25 October) will be an important release.
“And you may ask yourself, “Am I right? Am I wrong?
And you may tell yourself, “My God! What have I done?”
Talking Heads, ‘Once in a Lifetime’
Growing up, one of my favourite bands was Talking Heads. An outstanding band from the mid-1970s-early-1990s, Talking Heads had three songs (including ‘Once in a Lifetime’) ranked by the Rolling Stone magazine as being among the 500 songs that shaped Rock and Roll (according to Wikipedia). In 2011, Rolling Stone in 2011 ranked the band as one of the 100 greatest artists of all-time (albeit they were ranked at number 100).
There is an element of the lyrics that must confront the RBA every time they contemplate an interest rate decision. But right now the RBA is comfortable that they are getting it right. Business sentiment is strong, leading to a robust run of jobs growth. A strengthening global economy is playing its part, with exports (iron ore, education, tourism, agriculture) powering ahead. An infrastructure boom is taking place. The end of the mining capex decline is within sight (mining exploration spend was up 7% in Q2). More generally, firms are increasingly looking to boost their Capex Budgets.
The economic soft spot has been the consumer, weighed down by worries about unemployment, higher household debt and negligible real wages growth (wages growth after inflation). But even here there is good news. With jobs now more plentiful, consumers are again starting to open their wallets and purses. Retail sales have risen strongly for the past couple of months. The RBA expect that future household spending will remain constrained. The RBA also noted that house price conditions are easing, notably in Sydney.
A stronger domestic and global economy typically would (in time) mean higher interest rates. And that again might be the case. But there are a couple of factors keeping the RBA’s fingers from the rate hike trigger. For a start, inflation remains too low. Underlying inflation is running around 1.75%, and both consumers and firms indicate that they currently see few signs of price rises. The RBA is forecasting a gradual rise of inflation as the economy continues to strengthen. The importance of inflation makes the next CPI figures (released 25 October) as the biggest piece of domestic economic information still to be released in 2017.
One reason that inflation is struggling to rise is that there remains plenty of spare capacity in the economy. The unemployment rate is still too high (a bit above 5.5%). And the underutilization rate (the unemployment rate plus those working part time who would like to work full time) is even higher. Capacity utilization rates have risen and are near their post-GFC highs, although still only a little above historic average levels. Sustained strong growth should (in time) see a decline in the underutilization rate (and some rise in wages growth).
The other key reason that the RBA is in no rush to hike rates is the strength of the $A. The RBA again noted in its Statement that a rising exchange rate would lead to a softer economic and inflation outlook than forecast. Part of the reason behind the rise of the $A in recent weeks can be put down to a weaker $US. But expectations that interest rates globally will remain low has put upward pressure on the $A (making Australian interest rates relatively more attractive). A low current account deficit and high levels of foreign direct investment is supporting the $A. Most importantly, the little Aussie battler is getting plenty of support from rising commodity prices.
In a recent Reuters poll of financial market analysts on the outlook for the $A the median forecast was 0.77c in three months, and 0.76c in both six and twelve months. Other implications from the poll include:
- Very few analysts expect the $A to fall below 0.70c any time over the next year;
- But very few analysts expect the $A to move above 0.80c (despite the current value);
- Around 25-30% of analysts expect the $A to remain in its current range of 0.7750-0.80 for the next year;
- The most popular forecast is 0.75c in 6-12 months, around the long-term average for the $A (although as noted, the median forecast is a little higher).
When taken together with the excess capacity still evident in the domestic economy, low inflation and the medium-term global economic risks (the RBA again noted the rise of debt in China) it is easy to see why the cash rate was kept unchanged. The majority of financial market forecasters expect no change in the cash rate over the next year, with a rate rise not expected until the December quarter 2018. At the time of writing, financial markets were a little more aggressive with a rate hike essentially priced by the September quarter of next year, and a bit over a 25% chance of a second priced by end-2018.
Over 20% of analysts project 50bp of rate hikes by end-2018/early-2019. This is not ridiculous. In the event that interest rates do rise (which is far from certain) there is a reasonable chance that rates could rise at least twice to unwind the two 25bp cuts that took place in 2016. Virtually no analysts are forecasting any rate cuts for the foreseeable future.
If the majority of analysts are right and rates do not change until the December quarter 2018, that would be the longest period without a cash rate change since at least 1980.
Some interest rate decisions, like the one taken following the September meeting, was relatively straight forward. Others are harder. As the Talking Heads went on to say in “Once in a Lifetime”, ‘Same as it ever was, same as it ever was’.
We live in interesting times.