RBA lowers inflation forecasts, ready to cut rates again


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For the first time in a year, the Reserve Bank has cut interest rates. Peter Martin explains why.

The Reserve Bank has reiterated its commitment to its inflation target, suggesting it will not shy away from further rate cuts if price and wage growth remains sluggish.

The bank, which on Tuesday cut the cash rate to 1.75 per cent after surprisingly weak quarterly inflation data, said the board “judged that the prospects for sustainable growth in the economy with inflation returning to target over time, would be improved by further easing of monetary policy.”

In the semi-annual Statement of Monetary Policy, the RBA lowered its forecasts for underlying inflation to between 1 and 2 per cent for the year to December, from 2 to 3 per cent, noting “broad based weakness in domestic cost pressures”.

That represents a half a percentage point revision from its previous inflation forecasts.  More significantly, RBA now does not expect inflation to return to the lower end of its 2 to 3 per cent target inflation range until 2018,

On Tuesday, the RBA responded to asurprisingly low inflation reading which implied an annual headline inflation rate of 1.5 per cent over the year – by cutting the cash rate for the first time in 12 months. That was despite strong growth and unemployment data and an apparent reluctance to cut rates given monetary policy was seen as losing its efficacy while creating potential financial stability risks by inflation asset prices.

Friday’s downward revision in the central bank’s inflation forecast was widely expected by the market but will further reinforce expectations that another interest rate cut is on its way.

Growth and unemployment forecasts were ‘little changed’ from the February statement, which predicted GDP growth of around 2.5 per cent through to June 2016, consistent with the government’s budget numbers. While the RBA does not explicitly offer a forecast for the unemployment rate, a chart included in the statement implies it expects a decline to about 5.25 per cent – from about 5.75 per cent.

Unemployment will “remain around current levels for the next year and then gradually decline as growth in economic activity strengthens,” the RBA said.

The RBA reiterated its previous statements that low inflation would provide it with “scope” for further rate cuts, which it duly seized upon on Tuesday. But the impact on already elevated house prices led to some apprehension.

In its decision to cut interest rates, the RBA said the board “took careful account of developments in the housing market” but noted that steps taken by regulators to tighten housing credit had led to an “abatement” of pricing pressures, therefore providing them with comfort to act.

The broad-based nature of the lower than expected March quarter inflation numbers coupled with weak wage growth forced a “reassessment of the extent of inflationary pressures,” the RBA said.

The RBA, along with other central banks around the world, are trying to understand why wage inflation is weak even as the unemployment rate falls.

Wage growth in recent years has been far lower than suggested by its historical relationship with measures of spare capacity such as the unemployment rate,” the RBA said.

This might be explained, the RBA said, by declining inflation expectations, a fall in national income and a rise in labour market flexibility while noting this was evident in other advanced economies.

Still weak wage growth coupled with rising employment is a phenomenon that central banks are not easily able to explain, nor formulate an appropriate response.

The RBA noted that one measure of labour costs – average earnings per hour – declined in the December quarter with growth comparable to the periods of weakness in the early to mid 1990s at a time of considerably higher unemployment”

This may be due by shifts within industries – such as workers that were paid well to work on the mines returning to lower paid construction jobs, workers being able to replace departing staff with new staff on lower salaries and a reduction in allowances.

Online Source

The Indian Telegraph sydney Australia

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