RBA holds rates at 1.5% as “downside risks have increased” blog image

RBA holds rates at 1.5% as “downside risks have increased”

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The Reserve Bank of Australia (RBA) is growing less optimistic about the country’s economic outlook. The RBA has flagged downgrades to its upcoming GDP growth forecasts and has warned that downside risks have increased according to Governor Philip Lowe.

Despite the noticeable deterioration in recent Australian economic data, the bank chose to keep its cash rate the same at 1.5% in February, an outcome that was widely anticipated by financial markets.

It likewise pushed back against growing market expectations that it may be required to cut the rate of interest again this year, hoping that the above-trend economic growth will help to gradually lift inflationary pressures in the years ahead.

Mr Lowe believes that more progress in reducing unemployment and having inflation return to the 2-3% target is expected. However, the progress is likely to be gradual.

He adds, “Taking account of the available information, the Board judged that holding the stance of monetary policy unchanged at this meeting would be consistent with sustainable growth in the economy and achieving the inflation target over time.”

While the growth downgrade implies that progress in returning inflation to midpoint of its target might be a lot more gradual than before, by the RBA mentioning that it still sees that happening, suggests that the next move in the cash rate is likely to be higher.

“The central scenario is for underlying inflation to be 2% this year and 2.25% in 2020,” Mr Lowe stated. Underlying inflation is most likely to go back to within its target band, however not the midpoint over the forecast horizon. Previously, the RBA saw the Australian economy increasing by 3.25% this year and 3% in 2020.

From January to November 2018, underlying inflation grew by 1.75%. It has missed the RBA’s target for three consecutive years and appears to be slowing down further.

Mr Lowe continues to be optimistic that incomes and consumption levels will get better. While household income has been low over the past few years, he believes that it will pick up and support household spending. He added that the labour market conditions remain strong which should see some further lift in wages growth over time.

“A further decline in the unemployment rate to 4.75% is expected over the next couple of years,” he said. Australia’s growth outlook was being supported by “rising business investment and higher levels of spending on public infrastructure”.

While he believes that a stronger labour market will help to lift incomes and household spending in the period ahead, he did add caution on that view.

“The main domestic uncertainty remains around the outlook for household spending and the effect of falling housing prices in some cities,” he said.

Current state of the housing market

Recently, the housing market has deteriorated significantly, especially in Australia’s southeastern states. Lowe said that Sydney and Melbourne are “going through a period of adjustment, after an earlier large run-up in prices”.

Market conditions in both cities have weakened and rent inflation remains low. Mr Lowe said “credit conditions for some borrowers are tighter than they have been” with credit growth to financiers slowing “noticeably” while that to owner-occupiers had “eased”.

According to CoreLogic data, home values in Australian capital cities have fallen by 1.3% and 1.2% respectively in December and January. The December downturn was the largest percentage-wise since 1983. Tighter lending standards also contributed to a steep decline in new home sales and building approvals late last year.

Global downturn

Mr Lowe acknowledged that global growth slowed in the second half of the year, including Australia’s largest trading partner, China.

He said, “The outlook for global growth remains reasonable, although downside risks have increased. The trade tensions are affecting global trade and some investment decisions.

“Growth in the Chinese economy has continued to slow, with the authorities easing policy while continuing to pay close attention to the risks in the financial sector.”

The recent increase in financial market volatility was likewise pointed out by Mr Lowe. However, he suggested that the financial conditions overall “remain accommodative”, an outcome partly brought about by a shift in policy direction from the US Federal Reserve.

“Market participants no longer expect a further tightening of monetary policy in the United States,” he said. “Government bond yields have declined in most countries, including Australia.”

 

The RBA remains confident that it will eventually achieve its inflation mandate. As a result, this will probably see it repeat its previous view that the next step in the cash rate will likely be higher, in time.

The complete February monetary policy statement can be found here.

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Disclaimer

This article first appeared on Business Insider Australia.

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