Daily Commentary BY THE CURVE TEAM –

Growing Headwinds Challenging the RBA’s Outlook

3rd of July, 2018

As has been the case for many months there is no change in the cash rate expected from the RBA today. However pressure is mounting on the RBA’s glass half full rhetoric as headwinds to the outlook build. Meanwhile the overall setting of monetary policy is shifting despite the stable cash rate.

According to market pricing there is no chance of a rate move at today’s meeting, or any meeting between now and the end of the year. In fact, falling expectations for a rate hike now see no move priced in between now and the end of 2019 with no hike fully priced in as far out as the futures pricing goes.

The shift in market pricing over the past few months is a reflection of the growing headwinds that the RBA’s outlook is facing. The RBA has long acknowledged that the consumer poses the biggest risk to the outlook for the economy. However the steady deterioration in other data points suggest that the risks to the outlook are growing.

The risk that the housing market poses is growing by the month as housing values slowly slide lower and credit demand falls. Credit is the life blood of the economy and where it goes so does growth, not just in house prices but the broader economy.

For now the slow melt in the housing market will not cause too much concern for the RBA after the rapid rise in prices over the past few years. What will be a concern is if the slow melt gathers pace and becomes disorderly. When that happens, the impact of falling house prices spreads to broader economy activity and employment and then we have a problem.

Leading indicators of employment continue to suggest that employment growth will slow, making it harder to eat into the unemployment and the elevated levels of underemployment. This is not a good sign for the much needed wage growth that the RBA desires so much.

While the cash rate is stable and expected to remain so, mortgage rates are on the rise at a time when the housing market is already softening. We also have the large amount of interest only loans set to reset to principle and interest over the next 3 to 4 years to come which will put even more pressure on the market.

Governor Lowe made it quite clear at his appearance on the central banking panel in Portugal recently that the risk of lowering rates to get inflation back to the target bank quicker carried too high a risk. So don’t expect the RBA to come rushing to the rescue unless we get an utter capitulation in the housing market and broader economy.

So it will be very interesting how the RBA reconciles the growing headwinds building against their glass half full outlook for the economy. It is unlikely we will see a shift this month. With the next Quarterly Statement on Monetary Policy due after next months meeting, it sets up a perfect opportunity for the RBA to address the changing outlook.

David Flanagan

Director - Interest Rate Markets