Daily Commentary BY THE CURVE TEAM –

RBA Remains Defiant Amid Growing Headwinds

4th of July, 2018

The RBA remained resolute in their core message that accompanied their record breaking decision to leave rates on hold yesterday. While the core message of cautious optimism was retained, there is acknowledgement of  the growing number of risk that threaten the outlook.

Growth in the Australian economy, underpinned by exports, investment and government spending is still expected to increase, lifting wages and inflation gradually over the coming years. That was the core message from the RBA as they strive to remain a source of stability and confidence, retaining the same closing paragraph as we have become accustomed to.

While the core message was retained at the cash rate was left unchanged for a record 24 straight months since August 2016, there was some growing disquiet over the risks to the RBA’s outlook.

The threat from international developments appears to be growing with the statement saying “one uncertainty regarding the global outlook stems from the direction of international trade policy in the United States”. Developments on this front seem to be heating up and could get messy when the first round of US tariffs on China are scheduled to kick in on Friday this week.

The other international threat stems from emerging markets where the RBA said “there have also been strains in a few emerging market economies, largely for country-specific reasons”. While these symptoms of emerging market strain may be country specific, the root cause leads back to rising US interest rates and the rally in the USD.

Funding pressures in Australia, which we have widely publicised, are also a point of concern. While the RBA reaffirmed that developments in the US were one reason behind the tightness in funding markets locally they acknowledged there  “are other factors at work as well” and “it remains to be seen the extent to which these factors persist”. We are only three days into the new financial year but these tightness is funding markets is persisting.

However the biggest risk remains households where “income has been growing slowly and debt levels are high”.

This is of particular concern as the housing market continues to exhibit growing signs of weakness that looks more enduring than many people may of first thought. While the RBA sad “nationwide measures of housing prices are little changed over the past six months” and “conditions in the Sydney and Melbourne housing markets have eased, with prices declining in both markets”, the key is credit

The RBA highlighted that “housing credit growth has declined, with investor demand having slowed noticeably”. Where credit goes, so do house prices and overall economic growth.

So while other area’s of growth may prop up the headline GDP number, a prolonged pullback in credit growth will eventually drag economic growth lower in time.

David Flanagan

Director - Interest Rate Markets