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BILL’S BITES: RBA’s long summer

03:24pm December 11 2018

Watch Westpac chief economist Bill Evans break down the outlook for growth and the cash rate. (Josh Wall)

Despite the Christmas break looming, the Reserve Bank has much on their mind as they likely undertake a major review of its growth forecasts following a handful of notable recent developments.

First, last week’s GDP report revealed annual growth in the Australian economy slowed to 2.8 per cent in the September quarter, weighed by a particularly weak print on consumer spending and negative new dwelling construction.

A day later, RBA deputy governor Guy Debelle noted in a speech that there was “still scope for further reductions” in the cash rate. “It is the level of interest rates that matters and they can still move lower,” he continued, suggesting the Bank was likely to indicate a different approach to rates, as opposed to its position that the next move was likely to be an increase.

Critically, the Bank will be assessing the impact of falling house prices and tighter credit on the real economy prior to releasing their next forecasts in February (January is also the only month the RBA board doesn’t meet).  

As the deputy governor noted, it’s somewhat “unchartered territory”.

Even though prices have fallen by 9.6 per cent from their peak in Sydney and 5.8 per cent in Melbourne, these adjustments follow cumulative increases in Sydney (40 per cent) and Melbourne (32 per cent) over the previous four years, meaning affordability is still stretched. Unlike previous cycles where affordability was boosted by sharp reductions in interest rates and strong income growth, the necessary restoration of affordability in this cycle will need to come from prices.

The additional complication is that even if affordability has been restored and buyers are attracted back into the market, credit is being tightened by the banks. As we have recently seen in Perth, affordability can be restored but prices can still fall further if credit is tightened. This is playing out when the Australian economy will also be challenged next year by the political uncertainty of an election campaign and the ongoing threats from a global economic slowdown.

On the other hand, there continues to be optimism about jobs growth, consumer and business confidence, booming government infrastructure investment, strong services exports and a likely substantial fiscal stimulus from the upcoming Commonwealth Budget on April 2.

But Westpac Economics has long been sceptical about the RBA’s assertions that growth in 2019 was likely to be comfortably above “potential” of 2.75 per cent.

And come February 8 post the Xmas break, when the Bank will release the next Statement on Monetary Policy, 2018 growth is likely to be revised to 3 per cent, from 3.5 per cent and 2019 growth lowered to around potential.

To our knowledge, we have been the only forecaster consistently promoting the view that the cash rate was would remain on hold through both 2019 and 2020 as others, including markets, expected higher rates through 2019 and beyond. As recently as last month, markets were positioned with a 75 per cent probability for an RBA rate hike by end 2019.

That’s now shifted.

And from our perspective, a central bank forecasting growth around trend rather than well above trend is much less likely to feel the “responsibility” to normalise rate settings higher.

This material contains general commentary, and market colour. This material does not constitute investment advice. This information has been prepared without taking account of your objectives, financial situation or needs. We recommend that you seek your own independent legal or financial advice before proceeding with any investment decision. Whilst every effort has been taken to ensure that the assumptions on which the forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The ultimate outcomes may differ substantially from these forecasts. Except where contrary to law, Westpac and its related entities intend by this notice to exclude liability for this information.
 

William (Bill) Evans is Westpac’s economic spokesman and is responsible for all of our economic research. In 1991, Bill joined Westpac as the Chief Economist and Head of Research. A graduate of Sydney University (BEc. Hons I and University Medal) and the London School of Economics (M. Sc.), Bill has worked as Research Manager for the Reserve Bank of Australia and as a Treasurer at the Commonwealth Bank of Australia. Bill travels frequently, advising Westpac’s customers on the Australian economy and financial markets.

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