To cut to the chase, the Reserve Bank is forecasting it will have to cut its official interest rate by 50 basis points, knocking half a per cent off most mortgages.
In Friday’s quarterly statement on monetary policy (SoMP), the bank downgraded its forecasts of economic growth, inflation and consumption and further delayed its expectation of any improvement in unemployment.
Of concern for whoever wins the election, the RBA has shaved a quarter of a per cent off the Treasury’s GDP forecast for the new financial year, published in its Pre-election Economic and Fiscal Outlook (PEFO) less than three weeks ago.
The PEFO forecast year-average real GDP growth of 2.75 per cent for 2019-20, but the RBA is saying 2.5.
The RBA has downgraded Josh Frydenberg’s budget forecasts barely a month after he made them. What’s more, the outlook for the new financial year indicates the $1080 direct deposit tax cuts in July and August will have little if any impact.
Crucially, the RBA’s weaker economic outlook is based on the money market assumption that rates will be cut this year. Thus, the RBA is saying that – even with two 25-point rate cuts – it will barely achieve its minimum inflation target and that unemployment won’t improve until 2021.
We’re left to wonder how much worse the central bank would think the national outlook would be without the built-in rate-cut assumption to provide some extra stimulus.
The unemployment rate forecast based on ABS data. Source: ABS
The SoMP outlook makes the decision not to start cutting rates last Tuesday a little stranger. The governor’s brief statement after the board meeting seemed to be trying to find the glass half-full, but was betrayed in that ambition by internal inconsistencies.
The SoMP discloses the data the board was working off in deciding to leave rates steady for another month. It paints a picture of a softening economy with a somewhat brave belief that 2021 will see the unemployment rate ease to 4.75 per cent.
Three months ago, the RBA had expected core inflation to be running at 1.75 per cent at the end next month and hit 2 per cent by December. Now the forecast is for “trimmed mean” inflation to be 1.5 per cent next month and not reach 2 per cent until June next year.
How inflation will pick up to that elusive goal is not clear when there’s no expectation of a tighter labour market and consumption is thought to weaken further.
Under the headline “Consumption growth has been revised lower”, the RBA says:
“Consumption growth was weak in the second half of 2018, despite the ongoing improvement in the labour market. Consumption is expected to remain soft over coming quarters because of weak household disposable income growth over the past few years and weak housing market conditions.
“Growth in consumption is expected to be 2 per cent over 2019, and is then forecast to increase to be 2.75 per cent by mid 2021, supported by stronger growth in disposable income and the absence of a drag from housing market conditions.”
Where that “stronger growth in disposable income” is supposed to come from remains a mystery, given the minimal expected improvement in unemployment.
There’s certainly no indication in the SoMP of any downside to the assumption of interest rates being half-a-percentage point lower.
But there is a possible explanation for how the bank could simultaneously leave rates steady and make the case that they have to be cut: the bank doesn’t think trimming rates by 50 points at this stage will actually make any discernible difference to the economy.
Whoever wins the May 18 election, there will be the usual reassessment of the RBA’s mandate. It promises to be an interesting discussion.
