RBA: SoMP lifts inflation forecast but moderates outlook for employment - Westpac

Bill Evans, Research Analyst at Westpac, explains that there have been only minor changes in the Reserve Bank’s forecasts for growth, inflation, and unemployment in the May Statement on Monetary Policy.

Key Quotes

“Despite some bouts of schizophrenia over the last three months (growth in 2018 above 2017; growth above trend) the Bank has retained its growth forecasts of 3 ¼ per cent in the year to December 2018 and 3 ¼ per cent in the year to December 2019.”

“Furthermore, despite the Government being likely to forecast year average GDP growth of 3% in both 2018/19 and 2019/20 (to be announced in next week’s budget on May 8) the Reserve Bank has persisted with its more optimistic 3 ¼ per cent in both years. Some support to this confident growth outlook relative to February is that the forecasts include more stimulatory financial conditions with the AUD TWI 3% lower than in February and interest rates not expected to rise until the middle of next year.”

“The forecast for underlying inflation has been lifted for the year to June 2018 (1 ¾ per cent to 2 per cent) and the year to December 2018 (1 ¾ per cent to 2 per cent). All other forecasts for underlying inflation remain the same at 2 per cent for the year to December 2019 and 2 ¼ per cent for the year to June 2020.”

“Conclusion

• The inflation and unemployment forecast changes seem somewhat inconsistent. A reasonable recognition of the slowdown in employment growth this year might have been more consistently communicated if the inflation forecast had not been increased. In particular, it seems a little bizarre to expect underlying inflation to print 2% from a 1.3% base over the last 9 months.
• The Bank is aware of the key dynamic challenging the Australian economy. This is around weak household income growth at a time of very high debt levels; falling house prices; tightening financial conditions; and uncertainty around the actual level of full employment. The Statement provides little comfort that there is a confident interpretation and solution to these risks.
• In fact, the conclusion in the opening chapter of the statement that “if the economy continues to perform as expected, higher interest rates are likely to be appropriate at some point” is unconvincing. The problem with that conclusion is that a close reading of the Statement reveals considerable uncertainty around exactly how this performance will play out.
• Westpac is less comfortable than the Bank as to how these risks will develop, with softening household incomes, tightening financial conditions and soft asset markets all pointing to benign inflation and wage pressures with the unemployment rate stuck well above that full employment level.
• We are still looking for a convincing explanation as to why the Bank will see the need to tighten policy over the course of 2018 and 2019.”