Imminent cash rate rise remains unlikely
Mortgage holders were the winners on Melbourne Cup Day as the Reserve Bank of Australia (RBA) left the cash rate on hold for the 15th consecutive time.
In its statement, Reserve Bank of Australia (RBA) governor Philip Lowe said inflation remains low with both Consumer Price Index (CPI) and underlying inflation running a little below 2 per cent.
Lowe said in underlying terms, inflation is likely to remain low for some time, reflecting the slow growth in labour costs and increased competitive pressures, especially in retailing. [Underlying inflation measures the inflationary pressures in the economy that are predominantly due to market forces.]
The RBA has forecast that underlying inflation will be between 1.5 per cent and 2.5 per cent by the end of this year. But with the September inflation figure missing the mark there is some doubt as to whether this will be achieved.
Australia’s inflation number for the September quarter came in well below expectations at 0.6 per cent. Economists were expecting a rise of 0.8 per cent, which would have led to the year-on-year rate being around 1.9 to 2 per cent.
What is the relationship between inflation and the RBA’s cash rate?
The RBA believes that a flexible and medium-term inflation target is the best way to achieve medium-price stability. This inflation target is between 2 and 3 per cent and is designed to be an average over a period of years rather than something that needs to be met every month.
When the RBA raises the cash rate, it is usually because it wants to slow demand and the rate of inflation. Higher interest rates generally restrain lending growth, which slows demand and inflation.
If the RBA lowers the cash rate, it is generally trying to give the economy and inflation a boost by encouraging consumer spending and business investment. This is because lower rates are an incentive for businesses and households to borrow rather than save, thus lifting economic activity.
The RBA believes controlling inflation preserves the value of money and encourages strong and sustainable growth in the economy over the long term.
As inflation is a contributing factor to whether rates are raised on not, the soft September number is expected to stop any talk around RBA rate increases for a while.
No move, no surprise
This appears to be confirmed by economists after the RBA’s rate announcement on Tuesday. Canstar Group Executive (Financial Services) Steve Mickenbecker said the decision not to do anything was no surprise.
“Inflation is still below target range and even though jobs growth has been promising and sustained, the RBA wouldn’t want to move too early on rates with a threat of housing stress in the market,” he said. “The Reserve Bank bias is still to increase rates, in particular given the Bank of England and US Federal Reserve have increased rates in recent times, but now is just not the right time for Australia. The board will be looking for sustained growth indicators other than just jobs growth. So, I’d expect no move until at least the middle of next year.”
AMP chief economist Shane Oliver said RBA expectations for stronger growth ahead, high levels of business confidence and strong employment growth all argue against a rate cut, while a slowdown in the housing cycle, risks around consumer spending, weak wages growth and inflation and the too high Australian dollar argue against a rate hike.
“So, the most likely outcome is rates remaining on hold,” he said.
Commonwealth Bank of Australia (CBA) economist Gareth Aird said: “From a monetary policy perspective, the low inflationary pulse, which is reflecting soft wages growth and ongoing discounting in the retail sector, underpins our view that a rate hike is still a long way off.”
The RBA is also sounding more confident that when it comes to the housing market, its macroprudential restraints are working.
“Credit standards have been tightened in a way that has reduced the risk profile of borrowers,” Lowe said in the RBA statement. “Housing market conditions have eased further in Sydney. In most cities, housing prices have shown little change over recent months, although they are still increasing in Melbourne.”