Australia: Interest rates on hold - Westpac

Bill Evans, Chief Economist at Westpac, notes that as expected, the Reserve Bank Board kept rates on hold at its meeting on 1 August and while the Governor’s Statement was of interest it came four days before the detailed Statement on Monetary Policy which allowed an in depth insight into the Bank’s thinking.

Key Quotes

“The most important aspects of the Statement is the Bank’s growth, inflation and unemployment forecasts. The forecasts are predicated on two key assumptions. Firstly that the exchange rate will remain unchanged from the current spot level throughout the forecast period (out to December 2019). Secondly that interest rates will broadly follow market pricing.”

“In May, the AUD was assessed at USD 0.74 and TWI 64. For the August forecasts, it appears that an Australian Dollar of USD 0.80 and TWI 67 has been chosen. In May, markets only gave a slight probability to any rate movements in 2018 whereas today markets have priced in one rate hike of 0.25% by end 2018.”

“In summary, financial conditions in August have tightened markedly relative to May. Surprisingly however, the Bank did not lower its above trend growth forecasts for 2018 and 2019. These remain at 3¼% in 2018 and 3½% in the year to December 2019.”

“Westpac expects growth in both those years of around 2.5%, slightly below trend of 2.75%, and well below the above trend forecasts of 3¼ and 3½% respectively, we see in the SoMP.”

“From a policy perspective, the Bank’s forecasts of growth lifting to well above trend in 2018 and 2019, and inflation returning to the middle of the target band in 2019 would imply that it is expecting to be raising rates, probably in the second half of 2018.”

“However, the Bank has the luxury to delay any rate decisions until it can clearly test whether its forecast dynamics around higher consumer spending growth, a solid lift in investment spending, rising wages growth, benign housing developments and falling unemployment (along with what we suspect is a falling AUD) come to pass.”

“We are much less confident about that scenario and therefore expect rates to remain on hold next year.”