RBA minutes: Bank is still balanced around the policy risks - Westpac

Bill Evans, Research Analyst at Westpac, explains that as expected, the minutes of the monetary policy meeting of the Reserve Bank Board showed that the Bank has been somewhat encouraged by recent developments in the economy.

Key Quotes

“In particular, conditions in the labour market have continued to improve with employment growth being described as “broadly based across the states”. Solid employment growth is expected to continue given the current forward indicators in the labour market, although “spare capacity remains”.”

“On the other hand, the Board continues to be concerned about wages. Wage growth is described as stable at a low rate, and the forecast is for “growth in wages to remain low for some time, before picking up gradually in response to a strengthening labour market”. Evidence to support that view is that those industries with stronger employment growth are showing higher wage outcomes.”

“Another encouraging sign is around non-mining business investment, where forward looking indicators such as capacity utilisation and investment intentions from business surveys suggest a further pick-up. The Bank is reasonably cautious on this, forecasting that non-mining investment will “strengthen gradually”. It notes that non-residential investment is also improving although the data from the capex survey still pointed to modest growth at best, with sectors not covered by capex such as education and health looking stronger.”

“The dark side of the construction cycle centres around residential construction. The Bank appears to be considerably more optimistic here than Westpac. It accepts that construction has passed its peak but is still expecting a strong pipeline while continuing to note that “a considerable number of new apartments were scheduled to be completed in the period ahead”.”

“In the Governor’s statement following this board meeting, he pointed out that conditions in the housing market had eased, notably in Sydney. The minutes flesh out this point, and in particular note that conditions “had remained strong in Melbourne”. Overall, the minutes indicate a less comfortable assessment of developments in the housing market than was implied in the statement.”

“The issue of concern for the Bank is growth in housing debt continuing to outpace income growth. That summarises why the Bank is most concerned about wages, employment and house price growth.”

“As with the Governor’s statement, there is no attempt to “jawbone” the Australian dollar. It is accepted that weakness in the US dollar is a key contributor to AUD strength, but it also noted that the rise in the AUD “was weighing on domestic growth and contributing to subdued inflationary pressure”. The warning from the minutes in August is repeated, “a further appreciation of the Australian dollar would be expected to result in a slower pick-up in growth and inflation”.”

“The discussion on international economic conditions once again centres on China. It appears apparent that the Bank expects growth in the Chinese economy to slow over the course of the next few years, with the key challenge being balancing a commitment to short-term growth targets with the need to address high debt levels.”

“The implication is that Australia’s commodity prices can be expected to fall over the course of the next few years.”

“Commentary around the US Federal Reserve has changed somewhat. In previous minutes, the Board seemed to accept that the Federal Reserve would continue its tightening program. In these minutes, market pricing is noted to indicate that a rate hike was not expected until the second half of 2018. Given the Bank’s clear comfort with a lower AUD, this observation might indicate recognition of AUD holding higher for longer than had been anticipated previously.”

“Conclusion

• The minutes are not quite as upbeat as the Governor’s statement indicated. The improved labour market conditions are recognised but clearly qualified by an expected slow response from wages and ongoing spare capacity.
• Improving prospects for non-mining investment are noted, but the peak in the residential construction cycle has been reached, and prospects for non-residential investment are mixed.
• The easing of conditions in the housing market, especially in Sydney, are noted, but the qualification that the Melbourne market remains strong is added.
• The policy conundrum of rising household debt in an environment of low inflation is emphasised. While, the commentary notes that financial markets are giving “some expectation of an increase in the cash rate by mid-2018”, there is no signal in these minutes to suggest that the Board sees any urgency around interest rates.
• Westpac expects that concerns with weak income growth weighing on consumer spending and eventually the jobs market will dominate the policy debate in 2018.
• The sustained application of macro-prudential policies is likely to continue to ease conditions in housing markets precluding any need for the Bank to raise rates next year.”