Frank Uhlenbruch, Investment Strategist in the Australian Fixed Interest team, discusses the Reserve Bank of Australia’s (RBA) decision to hold rates steady. 

Key points from the RBA statement

• The outlook for global economy is reasonable, with risks tilted to the downside and global financial conditions remain accommodative.
• The Australian economy is expected to grow around 2.75% in 2019 and 2020.
• The Household consumption outlook is the main domestic uncertainty, but the RBA expect some pick up in household disposable income to support consumption.
• The labour market remains strong – the unemployment rate is expected to remain around 5% before falling to 4.75% in 2021.
• The adjustment in established housing markets is continuing. Mortgage rates remain low and there is strong competition for high quality borrowers.
• Inflation for the March quarter was lower than expected. Inflation is expected to gradually lift over the outlook period. Core inflation of 1.75% is expected by the end of 2019, lifting to 2% in 2020 and a little higher after that. Headline inflation of 2% is expected for 2019 due to higher fuel prices.
• The board acknowledged that the economy had spare capacity and that further labour market improvement is needed for inflation to be consistent with target. “…the Board will be paying close attention to developments in the labour market at its upcoming meetings”.

Market reaction

• Markets were looking for at least a move towards an easing bias and the broadly neutral statement led markets to push back the timing of the first easing and also to wind back expectations for the amount of easing.
• At the time of writing, three and 10 year government bonds were 7.5 basis points (bps) and 4bps higher in yield at 1.32% and 1.78%.
• The Australian dollar lifted from just under US$0.70 prior to the announcement to US$0.7040 after the announcement.
• Markets are assigning around a 90% chance of an August rate cut to 1.25% and around a 50% chance of a 1% cash rate in November.

Chart 1: Australian cash rate and 30-day interbank futures contract (%)

Source: Janus Henderson Investors, Bloomberg. As at 7 May 2019.

What we think

• We still see the balance of risks tilted towards easing given that the economy still has slack as evidenced by the broader lack of pricing power in the economy.
• Real retail trade fell by 0.1% over the March quarter and highlights that the weakness in consumption evident over the second half of 2018 has carried over into 2019.
• While tax cuts worth around 0.5% of GDP should help boost consumption in the second half of 2019, we still look for the RBA to cut the cash rate to 1% by November 2019 and see that as the low point in this super-easing cycle which has both structural and cyclical elements.

All views as at 4pm 7 May 2019.