■ A weak and uncertain international environment continues to pose downside risks to the domestic growth story.
■ An inflation profile expected to remain within the RBA’s 2‑3% target range means an easing bias remains in place.
■ We expect a 25bpts cut in August, taking the official cash rate to 3¼%.
The minutes of the June RBA Board meeting provide little forward guidance on the direction of interest rates. The minutes do however confirm that the “finely balanced” decision of a June rate cut was primarily in response to the uncertain and weaker international environment. In particular, the potential effects of the Euro area crisis were highlighted. The minutes mentioned that there was a “reasonable likelihood” that the negative impacts from the Euro area would result in “precautionary” behaviour domestically and overseas. Along with the inflation outlook, this allowed the central bank to provide a “measure of stimulus” to support domestic activity.
Financial market sentiment took a steep downward turn in May, as concerns about the potential collapse of the Euro area increased. The victory of the pro‑austerity party, New Democracy, in the Greek elections has caused a short relief rally across markets. However, underlying economic weakness in the Euro area remains a concern. In particular, the ongoing banking issues in Spain and questions over Spain’s external support package remain front‑of‑mind.
Recent US data has generally been disappointing (particularly non‑farm payrolls) which has fuelled concerns that the US recovery will take longer than anticipated. Recent economic data on US housing activity has been more positive, albeit off a very weak level. The planned US fiscal consolidation due to begin in 2013 also clouds the US growth outlook.
The Chinese slowdown is also feared to have gone further than expected which could have negative effects to the Australian economy through trade linkages. The Chinese authorities have taken measures to support demand through lowering the reserve requirement ratio and providing additional subsidies for household consumption.
The minutes noted that recent domestic economic data was generally in‑line with forecasts made in the May Statement on Monetary Policy (note that the June rate decision was announced prior to the higher‑than‑expected QI GDP figures). Business conditions continue to be mixed between mining and non‑mining. Consumer sentiment picked up slightly in May, but is still below the long‑run average. The labour market has been a source of strength over 2012, with the current unemployment rate at 5.1%. However, the central bank reiterated that it expects the unemployment rate to rise over coming months. Interestingly, the minutes mentioned that various estimates of the expected impact on economic activity from the fiscal consolidation is estimated to be subtract around ¾‑1½% from real GDP growth.
Inflation forecasts at the bottom end of the RBA’s 2‑3% target range indicate that an easing bias remains in place. However, there are strong assumptions that underlie these forecasts. Primarily, the central bank expects that unit labour costs will slow, through lower growth in nominal wages and/or an increase in productivity. The QI national accounts revealed that productivity has begun to lift in recent quarters. But labour costs remain uncomfortably high, with average wages in QI 2012 running at the fastest pace since mid‑2007. This outcome poses a threat to the forecast of continued low domestic inflation.
We expect that the QII CPI data, released in July, will confirm that domestic inflationary pressures are well contained. This will allow the RBA to cut the cash rate again to ward off negative impacts of the uncertainty posed by the debt crisis in the Euro area. We expect another 25bpts cut in August, taking the official cash rate to 3¼%. However, a further deterioration in the international environment, particularly in the event of a full‑blown Euro area crisis, would see the central bank cut interest rates aggressively.
The above article is courtesy of CBA Ecomonics Department