Earlier today, the Australian dollar rallied after the Reserve Bank of Australia (RBA) delivered its first monetary policy statement for the year. What’s up with that?!
Apparently, the RBA hinted that it’s done cutting interest rates for now since its current policies would be enough to push growth and inflation to the central bank’s targets.
Is this the real life or is this just fantasy? Let’s break down exactly what the RBA said today:
On the international economy
The RBA cited improvements in the global economy, saying that business and consumer confidence have picked up. Increases in commodity prices have also boosted other economies’ inflation, at least enough for some countries to dial down their stimulus programs.
The RBA also shared that the improvement in the global economy has pushed commodity prices higher, which in turn boosted Australia’s national income. However, the RBA also warned that “uncertainties remain” despite above-trend growth expectations for some advanced economies.
The RBA also noted China – Australia’s largest trading partner – and its strong growth in H2 2016. The central bank remarked that higher infrastructure spending and property construction boosted economic activity, but that the “rapid increase in borrowing” mean that medium-term risks remain.
On Australia’s growth
Philip Lowe and his team sustained the positive vibe when they talked about the domestic economy. For starters, they downplayed Q3 2016’s negative GDP reading, saying that it mostly reflects “temporary factors” anyway and that “a return to reasonable growth is expected” for Q4 2016.”
For now, the RBA still expects around 3.0% growth “over the next couple of years” as Australia continues its transition from the mining investment boom. Specifically, growth is expected to be supported by increases in exports, growth in consumption a slowdown in the decline of mining investments, and pick-up in non-mining investments.
Despite all these, the RBA kept its inflation estimates steady, saying that the “subdued growth in labour costs means that inflation is expected to remain low for some time.” The RBA is currently estimating 2017’s CPI at above 2.0% with core inflation rising a bit more gradually.
On AUD’s current levels
As expected, the RBA kept the pressure on the Australian dollar (AUD). While it recognized that its weaknesses since 2013 have helped the economy transition from the mining boom, it also warned that “an appreciating exchange rate would complicate the adjustment.”
On the labour market
Aside from remarking on the “subdued costs of labour growth,” the RBA also noted that labour market indicators remained mixed across the country. For one thing, the unemployment rate has ticked higher even as more workers had found full-time jobs in 2016. Fortunately, leading indicators are currently pointing to “continued expansion” in the next few months.
Aussie bulls attacked
Not surprisingly, the RBA’s optimistic tone sat well with Aussie bulls. The comdoll was pushed higher against almost all of its counterparts and maintained its lead until the start of the London session.
AUD/USD jumped from a low of .7635 before capping the session at .7673, while AUD/JPY rocketed from 85.24 to its 85.87 closing price. Ditto for EUR/AUD, which fell from 1.4059 to 1.3957 and GBP/AUD, which dropped from 1.6334 to end the session at 1.6254.
For now, the RBA believes that its two interest rate cuts last year will be enough to push growth and inflation to its targets. In fact, its exact words are (emphasis ours):
“Taking account of the available information, and having eased monetary policy in 2016, the Board judged that holding the stance of policy unchanged at this meeting would be consistent with sustainable growth in the economy and achieving the inflation target over time.”
Others aren’t impressed, however. They argue that the RBA is being too optimistic at this point, and that Lowe and his friends are overestimating the impact of higher commodity prices on Australia’s exports and the continued improvement of non-mining investments.
See, gains from higher commodity prices will likely translate to more profits for producers than additional jobs and/or higher wages. Aside from that, there’s no underlying trend supporting sustained improvements in non-mining activities. In fact, the RBA’s last word on capex outlook was that it’s “subdued.”
Last but not the least, the RBA has probably not factored that AUD’s major counterparts are being jawboned to death. And, with record low wages and a stronger currency, it’s likely that the RBA would have to restart its stimulus engine before the year ends.
How about you? Do you think that Australia’s economic conditions are good enough to put the brakes on cutting interest rates?
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