Daily Commentary BY THE CURVE TEAM –

RBA Holds Course as Risks Build and Here is Why

7th of November, 2018

The RBA left rates on hold as expected yesterday and gave us some insights into what to expect in Friday’s Quarterly Statement on Monetary Policy and their outlook for interest rates.

Australia’s record run of an unchanged cash rate was extended yet again when the RBA Board left the cash rate on hold as was widely expected. Importantly, they gave us some insights into their next quarterly update and it won’t be what many were expecting.

In the accompanying statement to yesterday’s decision to hold the cash rate at 1.50%, the RBA said “the forecasts for economic growth in 2018 and 2019 have been revised up a little”. That might surprise a few with the statement adding “the central scenario is for GDP growth to average around 3½ per cent over these two years, before slowing in 2020 due to slower growth in exports of resources.”

The RBA is also confident in the outlook for employment, saying “with the economy growing above trend, a further reduction in the unemployment rate is expected to around 4¾ per cent in 2020.”

While the RBA’s persistent optimism is at odds with market pricing for the cash rate and many commentators, some who are now calling for cash rate cuts, it is consistent with their desire to be a source of stability and confidence. It is also consistent with the most recent data on growth and employment.

I am of the view and agree with many others that the longer the deterioration in the housing market persists, the greater the risk of a negative feedback loop emerging. This feedback loop would see falling house prices impact economic activity through lowering consumption and putting pressure on the employment market.

The RBA will be acutely aware of this risk too and acknowledges as much saying that “one continuing source of uncertainty is the outlook for household consumption.”

However, the key is that until that risk shows signs of materialising, there is no need to add unnecessarily to the uncertainty. Were they to dedicate more column space to the potential fallout from a falling housing market, they would only fuel that uncertainty and undermine confidence. This would in turn increase the likelihood of the negative feedback loop emerging and becoming engrained.

That explains why there is such a divergence between the RBA’s central scenario and the market’s expectations around the outlook.

I would expect that if or when the second round impact of falling house prices becomes apparent, the RBA will adjust their central scenario accordingly. Until then, the RBA will continue to project a cautiously optimistic outlook consistent with their attempt to be a source of stability and confidence.

David Flanagan

Director - Interest Rate Markets