Weekend Economist: Dovish downgrade

The Reserve Bank's downward revision of its growth forecasts suggests a weak outlook for employment, wages, and non-mining investment will present serious obstacles to rebalancing the economy.

The Reserve Bank has lowered its growth forecast for 2014 from 2.5 per cent-3.5 per cent to 2 per cent-3 per cent. That is quite significant. These growth forecasts for 2014 are now consistent with our own forecasts.

It has maintained its forecast for growth in 2013 at 2.25 per cent and growth to June 2014 at 2.5 per cent. That means that whereas in August the Bank expected that growth in the second half of 2014 would reach a comfortably above-trend pace of around 3.6 per cent, it is now expecting growth in 2014’s second half of a still below-trend 2.5 per cent.

If a central bank is forecasting below-trend growth so far out, it should be considering the possibility that the economy needs further policy stimulus. That is consistent with the description of discussions at Board level in the penultimate paragraph in the overview to the Statement: that "it was appropriate to hold the cash rate steady, but not to close off the possibility of reducing it further, should that be needed to support economic activity consistent with the inflation target".

The growth forecast of a return to above-trend growth in 2015 is retained at a very wide 2.75 per cent-4.25 per cent.

In effect these forecasts indicate that the Bank has "delayed" its forecast return to above-trend growth by a year.

The inflation forecast has been slightly increased in the near term. Underlying inflation is still forecast to hold at 2.25 per cent, although it is now forecast at 2.5 per cent in the year to June 2014, up from 2.25 per cent. That upgrade largely reflects a slightly higher than expected print for the September quarter but the forecasts for 2014 and 2015 remain unchanged at 2-3 per cent and 1.75-2.75 per cent respectively. (The lower forecast in 2015 is related to the reversal of the "carbon price" effect.)

The most important reasons behind the downgrade in the growth forecasts are around business investment. Following further liaison with the mining companies, the bank has downgraded its forecasts for mining investment with "some large projects delayed or looking less likely to proceed".

It appears that the Bank has also revised down its forecasts for non-mining investment. It states: "Surveys of firms' intentions suggest that there will be little growth in non mining business investment over the next year or so". This is quite a significant development in the Bank's assessment of Australia's growth prospects. Various communications from the Bank have emphasised the importance of the rebalancing of business investment towards non mining. It appears that, despite the recent lift in business confidence measures, the Bank is unconvinced that these measures indicate a lift in investment in 2014.

On the other hand, there has been a modest uplift in the forecast for consumer spending due to strengthening conditions in the housing market with increased turnover and prices. However, the outlook for the labour market and incomes has been revised down: "the profile for employment has been revised down slightly with the unemployment rate expected to continue to rise for the next year or so". Wage pressures are likely to remain limited. This lift in consumption spending is also expected to be boosted by a modest decline in the savings ratio "towards the lower end of the range seen over recent years."

There is little emphasis on risks around a housing bubble. The boost to house prices is seen as promoting new construction activity. In discussing risks to their forecasts, the concerns would be around a return to increasing household leverage, "although to date growth of housing credit overall remains moderate."

A big drag on demand is seen to be the public sector, with the growth in government spending being around one third of the normal pace – "growth of public demand over the next few years will continue to be the weakest seen for at least 50 years."

Another reason for the lower growth forecasts was around the Australian dollar. The forecast of the Australian dollar was 5 per cent higher than in August. The Bank notes that "a further depreciation similar in magnitude to that seen earlier this year could be expected to see growth return to trend ,or even above trend, sooner than forecast".

This is a decidedly more dovish Statement than was expected. While we anticipated the Bank using fairly moderate language around prospects for the economy in order not to "talk up" the Australian dollar, we did not expect such a growth downgrade. The concerns around the larger than expected slowdown in mining investment; the weak outlook for employment and wages; a clear downward revision in the outlook for non-mining investment; and acceptance of headwinds coming from public spending support our view that the Bank continues to maintain an easing bias.

Concerns around a "housing bubble" seem limited and, quite frankly, given the multiple headwinds discussed above, a wealth and construction based boost to activity from the housing market seems to be, from the Bank's perspective, the “only hope” for the rebalancing of the economy in 2014.

Markets have summarily dismissed our call for lower rates in 2014. With the Bank forecasting below trend growth in 2014, revising down the momentum in the second half of 2014 from 3.6 per cent to 2.5 per cent, we are comfortable with our "out of market " call. We are also pleased to see that the Bank has a similar growth outlook to our own forecasts. We continue to anticipate a further rate cut of 0.25 per cent in February to be followed by a further move in May.


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