INSIGHT: RBA Bias Tilts Towards Neutral But Alert To Risks

— Any Labor Mkt Weakening May Put RBA Cut Back on Table
— RBA Sees Risks More Balanced Now Compared With August
— RBA View Consistent With Current Market Pricing

By Sophia Rodrigues

SYDNEY (MNI) – The Reserve Bank of Australia may have tilted towards a more neutral policy bias but it remains alert to risks that could force a cash rate cut next year.

The stance is more neutral now because, compared to August, the RBA sees the risks as more balanced following the recent rebound in commodity prices and new data showing underlying inflation has been steady year-on-year in the last three quarters.

At the same time, some concerns remain, with any weakening in the labor market among the key risks that could trigger a cut next year. The risk surrounding Chinese growth also remains but that’s more a medium- to long-term story than a near-term concern.

The RBA’s stance is consistent with market pricing, which sees a 40% chance of a 25bps cash rate cut by August next year.

The RBA will spell out the risks in greater detail in the quarterly Statement on Monetary Policy, due Friday. But it is plausible that a turning point has been reached as far as inflation and wage costs are concerned.

The RBA has noted that underlying inflation has been stable around 1.5% in year-on-year terms for three quarters in a row. A rise in headline inflation in Q3 may also bode well for the inflation outlook through its likely impact on inflation expectations. The RBA has noted that inflation expectations have not fallen further recently.

Wage price growth has also been stable for the last six quarters. Additionally, second quarter national accounts data showed a rise in average earnings.

The recent sharp rebound in commodity prices has also given the central bank cause for optimism, though the RBA is too cautious to assume the rise will be sustained in the longer run. The increase means the nation’s terms of trade are expected to rise for the third straight quarter in Q4 and more sharply than in the previous two quarters.

A rise in the terms of trade would lead to an increase in nominal GDP and will have a flow-on effect on household consumption. The RBA is also optimistic that would lead to an increase in wage prices from the current low levels.

At its board meeting Tuesday, the RBA left the cash rate unchanged at 1.5% and didn’t provide any policy guidance for the fourth statement in a row. There was little reason to provide guidance because the RBA’s key forecasts for growth and inflation are little-changed compared to February.

With risks now more balanced compared with August, an easing guidance would be unjustified, especially as governor Philip Lowe has repeatedly said that the RBA would use the flexibility in its inflation targeting framework. That flexibility means the RBA would be tolerant of inflation staying below the target band for longer if financial stability is a bigger worry.

The RBA also didn’t see a hold-for-longer guidance as appropriate when the outlook is for inflation to remain quite low and labor market indicators remain mixed.

Currently the RBA is taking comfort from data showing a fall in the unemployment rate to 5.6% in September, which was better than it expected in August.

Based on current indicators, the RBA’s expectation is for a continued expansion in employment in the near term. If that expansion stalls and the jobless rate starts moving up, it would mean spare capacity in the economy is increasing. A rise in the jobless rate may also affect RBA’s forecast for household consumption growth.

The former would put at risk the RBA’s forecast for inflation to gradually pick up while the latter would dampen the economy’s growth prospects. It is very likely the RBA would consider a cash rate cut in such a scenario, especially if it judges that such an action wouldn’t put financial stability at greater risk.

–MNI Sydney Bureau; tel: +61 2-9716-5467; email: sophia.rodrigues@mni-news.com

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