Westpac’s Bill Evans – Reserve Bank Board Minutes emphasise the virtues of steady rates: FXWW

From the FXWW Chatroom: The minutes of the May monetary policy meeting of the Reserve Bank Board repeated the assertion that first appeared in the April minutes. That is that “members agreed that it was more likely that the next move in the cash rate would be up rather than down”. This observation is contingent on the economy evolving in the way the Bank currently expects which is “a gradual pick-up in inflation as spare capacity in the economy is absorbed and wages growth gradually picks up”. Nevertheless the Board observed that spare capacity in the labour market would remain for some time.
Using this terminology might create challenges for the Bank in future. If the term is ever deleted from the minutes markets are likely to take that as a sign that the Bank’s policy stance has changed.
In a new turn of phrase, the minutes note that while this expected development was unfolding, “it would be appropriate to hold the cash rate steady and for the Reserve Bank to be a source of stability and confidence”.
That implies a badge of honour” to have steady rates rather than a stance that needs to be justified in a world where other central banks are tightening policy.
In these minutes, there is a more detailed discussion on the outlook for housing. In particular, the Board notes that “a further tightening in lending standards in Australia, particularly in the context of the current high level of public scrutiny of Banks, was possible which would affect household borrowing and spending”. The recent release ( since the Board meeting) of housing finance data showing that new lending to investors was now down 26% over the year is certainly consistent with those concerns.
The clear positive development for the economy has been the strong boost to non-mining business investment particularly non- residential construction. The Bank is justified in expecting that this strong momentum will be sustained,.
However there remains the concern that wage pressures may take some time to emerge. Indeed the Deputy Governor highlighted the key risk to the Bank’s outlook in his speech this morning. He nominated that risk as being that the level of the unemployment rate needed to spark wage and inflation pressures might be lower than the Bank’s current unemployment forecast which is for about a ¼ per cent fall by June 2019. The Board discusses this prospect when it talks about the wage price index not picking up as quickly as in the past when business surveys identified some shortage of suitable labour. The Board discussion moved to international evidence which shows similar inertia in wages and they discussed possible reasons including competitive pressures from globalisation and technological change.
The Board is sticking with its above-trend growth outlook which they believe will be sufficient to reduce spare capacity in the economy and restore the move to a lower unemployment rate.
There may be some source of embarrassment in these minutes in that it is noted that “recent data on retail” suggested that momentum had continued in early 2018. Since the Board meeting, the retail sales report showed that real retail sales had grown by a very modest 0.2% in the March quarter.
There is a sign that confidence in the global economy has waned a little. The Bank’s forecast now indicates that global growth is expected to ease, albeit still above-trend, over the next couple of years. Rising bond rates, particularly in the US, might take some momentum out of the world economy.
The Bank continues to be quite relaxed about the Australian Dollar noting that “it had remained in a narrow range over the previous two years relative to the US dollar and in trade weighted terms”.

Conclusion

If anything, these minutes seem to imply even greater patience with the current policy of steady rates. In describing the current policy as “a source of stability and confidence”, the Bank is clearly contrasting its policy with the Federal Reserve’s ongoing tightening cycle, but feels no embarrassment with its stance. The issues remain the same, associated with developments in the labour market, inflation and wages. In that regard however, the evolution of consumption in the context of a very low savings rate and the impact of tightening financial conditions on the housing market and house prices will be critical.
Westpac continues to expect that the Bank’s policy of “stability and confidence” (rates on hold) will be maintained throughout 2018 and 2019.

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