The Reserve Bank of Australia (RBA) has confirmed an on-target inflation outlook allowed it to postpone an interest rate rise on Tuesday, but a postponement is not the same as a cancellation.
Borrowers should be aware of the basis for the benign inflation outlook forecast in the RBA’s quarterly Statement on Monetary Policy released on Friday.
“The forecasts are based on the technical assumption of a rise in the cash rate over the forecast period , with the assumed path broadly consistent with market expectations as the statement was finalised,” the RBA said.
The statement was finalised on Thursday, when the futures market had factored in a rise in the cash rate from the current 3.75 per cent to around 4.5 per cent by the end of the year and not much below five per cent by early in the second half of 2011.
The assumptions – like the RBA’s standard assumption of a steady exchange rate – are by no means forecasts and should not be seen that way.
But they do mean that if things pan out in line with the forecasts, then the RBA expects rates to rise.
The forecasts themselves say underlying inflation, which the RBA estimates was 3.25 per cent (rounded to the nearest quarter per cent) through 2009, will ease to three per cent by mid-2010, then 2.5 per cent by the end of the year before inching up to 2.75 per cent by the end of 2011 and into 2012.
The RBA’s target is to keep inflation between two and three per cent on average over time, and uses measures of underlying inflation to check its progress.
The reason for that down-up pattern in the forecasts is the residual impact of the economic slowdown, then the early effects of the recovery.
“The decline in quarterly inflation rates reflects the significant easing in wage growth and capacity pressures over 2009, as well as the substantial appreciation of the exchange rate,” the RBA said in the statement.
The effect of the downturn will operate with a lag, depressing inflation “for some time”.
“Underlying inflation will then pick up a little toward the end of the forecast period , reflecting both a pick-up in wage growth from low levels as the labour market tightens and higher levels of capacity utilisation in the economy,” the RBA said.
After growing by an expected two per cent through 2009, implying a December quarter rise of a bit over a half per cent, gross domestic product is forecast to rise by 3.25 per cent through 2010 and 3.5 per cent through 2011.
Those growth rates about, or marginally above, the long-term average.
The RBA is betting that will be enough to improve the lot of jobseekers.
“The unemployment rate is now forecast to decline modestly over the period to mid-2012,” it said.
For policymakers, the uncertainties around the forecasts are as important as the outcomes they predict.
The RBA said the risks around the central forecast “appear to be fairly balanced”.
Growth and inflation could be higher than expected if confidence is boosted by a rise in commodity prices beyond the increase the RBA has pencilled in, boosting resource sector investment more than forecasts.
The main downside risk comes from abroad in the RBA’s estimation.
Growth in the world economy could undershoot expectations.
“The dynamics of the inventory cycle are generating much of the initial recovery in the advanced economies, as expected, but private demand will have to pick up for sustained growth,” the RBA said.
The difficult budgetary position many of those economies face is another potential constraint on growth – the fiscal stimulus cannot be open-ended.
So rates could rises faster or slower than the RBA currently assumes.
Overall, the statement is consistent with the consensus that, as long as the Australian economy continues to grow in line with forecasts, and inflation behaves as expected, then the RBA will continue to nudge the cash rate higher every now and then.