The Reserve Bank of Australia has revealed it has made a major change in its monetary policy stance, with a cut in the cash rate now even money bet.
Driving this change of heart is the acknowledgment that the economy could be weaker than it had expected – a belief of a small group of economists led by the AMP’s Dr. Shane Oliver who two weeks ago forecast the central bank could cut the cash rate twice later this year to 1%.
In his first major speech of the year, Dr. Lowe told the National Press Club in Sydney said that:
“Looking forward, there are scenarios where the next move in the cash rate is up and other scenarios where it is down. Over the past year, the next-move-is-up scenarios were more likely than the next-move-is-down scenarios. Today, the probabilities appear to be more evenly balanced.”
Previously the bank and Dr. Lowe had been saying the next move in rates would most likely be up – no time frame, but sometime in the not too distant future – that was the first forecast for 2018, then 2019 and then 2020.
Now the chances are even-stevens for the next rate movement to be a cut – it all depends on the health of household spending and the jobs market – any sign of weakness in either and the bank will be forced to cut rates again – for the first time since August 2016.
On top of this, Dr. Lowe revealed that the bank is now looking at a larger than previously expected fall in dwelling investment over the next two and a bit years – around 10%. The bank is looking for that to be offset by a pick up in mining investment and strong spending on public infrastructure and non-mining business investment which has recovered strongly in the last year.
“We will be monitoring developments in the labour market closely,” Dr. Lowe said in his speech yesterday.
“If Australians are finding jobs and their wages are rising more quickly, it is reasonable to expect that inflation will rise and that it will be appropriate to lift the cash rate at some point.
“On the other hand, given the uncertainties, it is possible that the economy is softer than we expect, and that income and consumption growth disappoint.
“In the event of a sustained increase in the unemployment rate and a lack of further progress towards the inflation objective, lower interest rates might be appropriate at some point. We have the flexibility to do this if needed.
“The Board will continue to assess the outlook carefully. It does not see a strong case for a near-term change in the cash rate. We are in the position of being able to maintain the current policy setting while we assess the shifts in the global economy and the strength of household spending,” he added.
Dr. Lowe’s speech made it clear the events in the housing sector are also being watched closely as would be the fallout from the banking royal commission and the changes it has recommended.
He said the “adjustment” in the housing market (falling prices and the level of investment) was affecting the economy more broadly through a slowdown in residential construction.
There had been concerns that this week’s banking royal commission final report could lead to a tightening of credit conditions which would then feed into the broader economy.
Dr. Lowe said credit standards had undergone a necessary tightening over recent years, conceding there had been concerns that lending to small businesses may had swung “too far” away from the sector.
“In that context, I welcome the report of the royal commission and the government’s response,” he told the Sydney lunch.
“The commission’s recommendations that bear on credit provision are balanced and sensible and should remove some uncertainty.
“I also welcome the commission’s focus on the importance of service – as opposed to sales – in the financial sector; the necessity of dealing properly with conflict of interest issues; and the importance of accountability when things go wrong.
The RBA left the cash rate unchanged at 1.5% at its meeting on Tuesday. Data releases in January and February have strongly suggested a weakening level of activity in the economy – weak retail sales, car sales falling, more falls in house prices in Sydney and Melbourne, falling building approvals and softening business conditions, as shown in the latest survey from the NAB.
Dr. Lowe said the bank had downgraded its forecasts for the economy which is now tipped to grow by 3% this year (previously 3.5%) and 2.75% 9around 3% previously) in 2020. He said this should be sufficient to see a “gradual” reduction in the jobless rate. Inflation is forecast to weaken over the rest of 2028 on a headline basis, but underlying inflation is forecast to hit 2% by the end of the year (it was forecast to hit 2% in 2018 but actually dipped to 1.8%).