Optimistic Reserve Bank holds interest rates steady for now

Lowe has noted some encouraging developments in the past month — but economists expect another cut before long.

Reserve Bank governor Philip Lowe. Picture: AAP

Cautious optimism from the Reserve Bank suggests interest rates will be on hold again next month.

However, economists say another rate cut and potentially even unconventional policy measures like quantitative easing will be needed before long without a big improvement in the economic outlook.

In a statement after a widely expected decision to leave the cash rate at a record low 0.75 per cent after the November board meeting, RBA governor Philip Lowe maintained that the economy appeared to have reached a “gentle turning point” after a “soft patch” in the second half of 2018.

The important final paragraph reiterated that “given global developments and the evidence of spare capacity in the Australian economy, it is reasonable to expect an extended period of low interest rates to reach full employment and achieve the inflation target.

“The board will continue to monitor developments, including in the labour market, and is prepared to ease monetary policy further if needed to support sustainable growth in the economy, full employment and the achievement of the inflation target over time,” Dr Lowe said.

But in the face of rising public concern about the unintended consequences of ultra-low interest rates, Dr Lowe added that “the easing of monetary policy since June is supporting employment and income growth in Australia and a return of inflation to the medium-term target range.” Moreover, the RBA governor noted some encouraging developments in the past month.

Uncertainty about the US-China trade and technology disputes continue to affect international trade flows and investment, and central banks overseas have cut rates due to such risks to the global economy and subdued inflation, but “expectations of further monetary easing have generally been scaled back over the past month and financial market sentiment has improved a little”, Dr Lowe said. Lessening expectations of US rate cuts might limit the Australian dollar’s rise and improving financial market sentiment could bring a positive wealth effect, lessening the need for more stimulus.

The Australian dollar was trading around US69.05c late on Tuesday.

The local currency has almost regained levels prevailing before the RBA started cutting rates again in June, but Dr Lowe noted that the exchange rate is “at the lower end of its range of recent times.”

The US sharemarket hit fresh record highs on Tuesday, while Australia’s S&P/ASX 200 sharemarket index rose 0.2 per cent to 6697 points, edging closer to a record high of 6875 points in July.

While the RBA cut its 2019 growth forecast to 2.25 per cent — from 2.4 per cent forecast in August — Dr Lowe said: “The low level of interest rates, recent tax cuts, ongoing spending on infrastructure, the upswing in housing prices in some markets and a brighter outlook for the resources sector should all support growth.”

The outlook for consumption is still the main uncertainty, as a sustained period of only modest increases in household disposable income continues to weigh on consumer spending, while the effects of the drought and housing construction downturn were added uncertainties, he said.

Retail sales data this week showed year-on-year volumes in the September quarter declined 0.2 per cent — the first fall in annual retail volume since the early 1990s recession.

Royal Bank of Canada chief economist Su-Lin Ong said that further monetary stimulus would be needed, but in light of Dr Lowe’s key final paragraph, the RBA looked set to sit on its hands for a while.

“The hurdle to cut further looks a little higher and we may well need several factors beyond just disappointing data such as (Monday’s) September retail sales and October ANZ job vacancies,” she said.

“Weaker global activity, renewed global easing impetus or a stronger Australian dollar may also be needed. Accordingly, we are pushing our December cut back to our original timing of February.”

Ms Ong said the RBA’s communication has been “more challenging than usual” this year and the timing of exact months for policy action “frustrating”, but far more important was what happened as the RBA moved closer to the effective lower bound.

“As we think about 2020 and a quantitative easing discussion that is likely to dominate, we are increasingly focused on how investors should position and the sequencing of further policy action,” she said.

Westpac chief economist Bill Evans said there was nothing in the RBA statement to prompt a revision of his forecast that rates would be on hold until a “final” cut in February.

“Following that move, the state of the economy will be such that further stimulus will still be required, without which an unwelcome lift in the Australian dollar would pose a significant headwind for the RBA’s current forecast of return to trend growth in 2020,” he said.

“Under those circumstances, it seems reasonable that the RBA might move towards some unconventional measures to boost demand and retain downward pressure on the Australian dollar.”

Similarly, CBA chief economist Michael Blythe said it was “difficult to say the RBA is done”.

“The debate about changes to the Statement on the Conduct of Monetary Policy has highlighted the RBA’s commitment to its 2-3 per cent inflation target,” he noted.

“The RBA has concluded that the only way to get to the target is by driving unemployment down to the ‘full employment’ level of 4.5 per cent. That is needed to lift wages and faster wages growth is needed to keep inflation ‘sustainably’ in target. And that looks a long way off.”

Treasurer Josh Frydenberg on Tuesday confirmed that after months of “careful consideration” he would not change the government’s official agreement with the Reserve Bank, meaning it will be left to pursue its 2-3 per cent inflation target.

There had been speculation the Treasurer might apply further pressure on Dr Lowe to get consumer price growth quickly within the band after nearly four years of below-target inflation.

“Following careful consideration and consultation between Treasury and the RBA I have concluded that the existing statement is consistent with the government’s and the RBA’s shared understanding of our monetary policy framework,” the Treasurer said.

“Not changing the statement provides continuity and consistency at this time of global economic uncertainty.”

Additional reporting: Patrick Commins