Uncertainty over inflation and wages keeps central banks in check – Westpac

In a week that was cut short by Thanksgiving in the US, policy makers again took centre stage and on the whole, their tone was cautious, explains Elliot Clarke, Research Analyst at Westpac,

Key Quotes

“For Australia, there was an increased focus on the minutes of the November RBA board meeting following the downward revision to their inflation forecasts in the November Statement on Monetary Policy. Consistent with these revised forecasts (underlying inflation of 1.75%yr at end-2018 and 2.0%yr at end-2019), the minutes cited an expectation that inflation will pick up “only gradually”.”

“While these revisions have been attributed to the ABS’ CPI re-weighting, to our mind the 0.5ppt revisions to the 2018 and 2019 forecasts are too large to solely be due to this factor. Disappointing wages growth and the consequence for consumer spending as well as more modest expectations for wages and inflation are clearly at play.” 

“Following the release of the November minutes, Governor Lowe delivered a speech to the Australian Business Economists’ Annual Dinner. In it he again highlighted the weakness in wages (growth in average hourly earnings “running at the lowest rate since at least the 1960s”) and paid close attention to the consequences for consumption: annual growth of near 2.5%yr against the RBA’s perennial expectation that it would accelerate to 3.5%yr. While they have now lowered their forecast peak in consumption growth to 3.0%yr, this is arguably still too high. We in contrast believe consumption growth is set to remain around 2.5%yr, delivering GDP growth near that figure over the forecast horizon.”

“A risk to our forecast that the cash rate will remain on hold through both 2018 and 2019 has been household credit growth’s material outpacing of income growth – resulting in a significant increase in household leverage. While the RBA and APRA remain vigilant, Governor Lowe and the RBA Board have taken confidence in macro-prudential policy’s power as both house price growth and credit growth have slowed. To that end, based on the real economy and financial stability metrics, keeping the cash rate unchanged is the most appropriate course for monetary policy.” 

“Taking a step back from the immediate, the release of the latest state accounts for the 2016/17 financial year offers a great deal of detail on sectoral and industry performance across the states. At the top level, in 2016/17 broad based gains across industry as well as in infrastructure investment by the public sector saw Victoria and NSW outperform, with growth of 2.9% and 3.3%. Of the mining states, Qld saw moderate growth, +1.8%yr, while in WA activity continued to contract as the mining investment downturn reached its nadir.” 

“Looking to the future, this week sees the long-awaited launch of Amazon Australia. The consequences for our economy will be varied and take time to play out. But briefly, based on offshore experience, expect further disinflationary pressures and margin compression for retailers, and a shift in the investment plans of retailers away from ‘bricks and mortar’ toward their online presence. While Amazon’s launch may spur consumption in the near-term, the overall impact on the volume of sales in the medium to long-term is likely to be marginal. On this point, it is important to recognise the power that sentiment and expectations around family finances have on spending. Until we see a lift in wages growth, consumers’ capacity to spend is likely to remain restricted.”  

“For those with an interest in the New Zealand economy, this week also saw the release of our New Zealand team’s quarterly outlook. The election of the new government in New Zealand has resulted in a softer growth forecast for 2018, but upward revisions to 2019 and 2020. On the RBNZ, our New Zealand team anticipates that current market expectations will be disappointed as the RBNZ remains on hold until late-2019.”

“Finally, turning to the US, the FOMC clearly sought to cement market expectations of a rate hike in December in their October/November meeting minutes. The economy was seen as continuing to enjoy above-trend growth thanks to robust gains for household consumption. Built on income gains as well as strong confidence, this trend is expected to persist. Inevitably though, an economy cannot be built on consumption alone. Investment is necessary, and this is an area of the growth outlook where we harbor doubts. Should, as we expect, investment growth remain tepid, then productivity and income growth will be held back. This is a key reason why we believe that this rate hike cycle is likely to top out around 1.875%, after the December decision and two further hikes in 2018.”