Considering the fundamentals of Australia's economy, the RBA's statement on monetary policy is surprisingly cautious with the exchange rate, global outlook and labour market cited as downside risks to growth.

The Reserve Bank Statement on Monetary Policy depicted a much less upbeat assessment of the Australian economy than was anticipated.

The growth forecast for 2012 was, as we expected, upgraded from 2.75 per cent (in May) to 3.5 per cent. However this adjustment was attributed entirely to the stronger than expected growth print for the first quarter and a positive outlook for the second quarter given the partial data on retail sales and exports. Surprisingly, the Bank did not upgrade its forecasts for the second half of 2012 from the May estimates or indeed its forecasts for 2013.

That forecast remains 2.5 to 3.5 per cent which appears to be a shade below trend. Recall that the May forecasts were released 3 days after the Bank had cut the cash rate by 50 basis points and just before rates were further cut in June by 25 basis points. It's reasonable to assume that forecasts around that period would have been subdued given the recent policy decision.

In not interpreting the surprising strength of GDP growth in the first half of 2012 as signalling a precursor to a sustained increase in momentum the Bank's analysis implies that the strength coming from the consumer was largely due to discounting and government payments in May and June.

In the very near term however the forecast for GDP growth in the year to June has been revised up from 2.75 per cent to 3.75 per cent.

With the first three quarters contributing 2.9 percentage points to growth and a comment that the first quarter may be revised down we can only conclude that the Bank is expecting the second quarter print to be around 1 per cent. Inflation forecasts have been revised up a little with underlying inflation in 2012 being estimated at 2.5 per cent up from 2.25 per cent.

The commentary indicates that this is due to an upward revision to tradable inflation and the carbon tax. Indeed it is noted that by mid-2013 underlying inflation will be in the top end of the 2 to 3 per cent range due to the impact of the carbon tax. As that effect works through, inflation is forecast to return to the middle of the band.

A key concern for the Bank has been the elevated level of non-tradable inflation. However, in today's statement the Bank indicates confidence that non-tradable inflation has returned to around average levels of the inflation targeting period and further productivity gains are expected to provide more downward pressure.

However, it also notes that its concerns around tradable inflation picking up with exchange rate stability gained some support from a modest increase in tradable inflation in the last quarter (our own view is that much of this rise was explained by a surprise increase in vehicle prices which can be tracked back to a one-off increase in state government charges in Victoria).

There are no real surprises around the global outlook with the major risks being identified around Europe although relative to the May statement global growth forecasts have been revised down and the weakness in Europe and the US is now assumed to be dampening growth in much of Asia.

The assessment of China is much less confident than in previous Statements although growth stability, albeit at a lower level than previously expected, is the Bank's theme around China. Overall, excluding the clear nervousness around Europe, it is still noted that "other risks to the global economy are also tilted to the downside".

There is more optimism around the housing market: "tentative signs that housing market conditions and residential building activity may be starting to improve."

The Bank appears to be a little surprised that the unemployment rate has not risen further. It points out that forward-looking indicators have weakened and are consistent with moderate employment growth with the unemployment rate set to edge up in the near term. Consistent with that private sector wage pressures are noted to have eased due to subdued demand in many non-resource industries.

It was particularly interesting to see extensive coverage being given to a theme that Westpac has recently discussed at length.

That is the turning point in the mining boom. Until now growth in mining investment has explained around half of Australia's GDP growth.

The Bank points out that the peak in mining investment is near. Resource investment is expected to decline gradually in 2013-14. This timing, albeit uncertain, has been brought forward in recognition of a slump in industry confidence.

The Bank expects that the impact of the slowdown will be offset by a pick up in mining exports and non mining investment. However it is not at all clear as to how the significant net contribution to growth from mining investment will be covered.

This subdued view around the impact of the mining boom on growth; coupled with recognition around falling terms of trade contrasts significantly with the Bank's upbeat assessment of those factors representing a threat to inflation that we saw through the first half of 2011. Such sentiment would certainly be a warring to those folks who are expecting the Bank to be tightening policy any time in 2013.

Surprisingly strong opinions have been raised around the Australian dollar: "important risks revolve around exchange rate developments", "the exchange rate has been high for some time... it is possible that the persistently high level of the exchange rate may be more contractionary for the economy than historical relationships suggest".

While we do not think that rate cuts will be adopted specifically to lower the exchange rate we are not in the camp that expects some form of direct intervention as a way to bring down the Australian dollar.

The reason behind this concern with the exchange rate is that while it has been relatively steady over the last 12 months the Bank estimates that the terms of trade have fallen by 10 per cent and is expected to fall further. When the exchange rate does not move in the same direction as the terms of trade implications for financial conditions are clear.

This relative movement signals that the role of the exchange rate has been to tighten financial conditions. The Bank notes that an additional constraint on the economy will be the fiscal consolidation which is now underway at both the federal and state levels.


We were expecting a more upbeat statement. The encouraging signals from the strong growth momentum in the first half of 2012 are largely put down to one-off effects rather than sustained expected growth.

While the Bank does acknowledge that there has been a tentative improvement in conditions in the housing market it has not been prepared to upgrade its growth forecasts for the second half of 2012 and 2013.

New issues which have emerged in this statement relate to recognition that the boost to growth from the mining boom is nearing an end; there is genuine unease around the potential contractionary impact of the currency; there appears to be surprise that the unemployment rate has not risen further; and while the inflation forecast has been modestly revised up that appears to be around the carbon tax and is therefore unlikely to have any policy implications.

This is not the statement of a central bank which has dismissed the possibility of further easing policy particularly given that borrowing rates are assessed as being only slightly below medium term averages.

The Bank may be wrong in its cautious assessment of the growth outlook but in adopting that as its central case the door is certainly left open for further monetary support in the event that some of the risks which are discussed above materialise.

Bill Evans is chief economist at Westpac.

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