The RBA’s neutral bias

Posted by

The RBA went back to an explicitly neutral bias at their Feb’19 policy window — via an interesting bit of subtlety.

The central forecast remains for a gradual decline of the unemployment rate and a very modest acceleration of core inflation, but the weight on the downside risks were increased. Thus, the official line was nudged to become “the probabilities of these two sets of scenarios have shifted to be more evenly balanced than previously”. So the next move could be up or down …

The market focused on the removal of the “next move is up” language, and priced in more cuts … notwithstanding that the RBA’s *modal case* is for stable policy, a falling unemployment rate, and gently accelerating inflation.

So what changed? After all, inflation has been too low for years, and they haven’t seemed to care. They might have justified a cut at any time since 2016 by reference to inflation — but they didn’t.

What changed is growth. There’s less of it, so they are less sure that inflation will accelerate back to their 2.5% target.

The most obvious change was to the current assessment of Australian growth. Recent history was sharply changed by the annual benchmark revisions to the National Accounts that were released with the Q3’18 report. This publication revised away the H1’18 GDP boom, with the consequence that the economy was both operating with a bit more spare capacity and carrying a bit less momentum into 2019.

The second change was to the housing market assessment. The housing market hit the skids in Q4’18. Price declines worsened from ~50bps per month to ~100bps per month. Consistent with this, lending finance approvals cratered (lending to households for dwellings ex-refi was -20%y/y). The most optimistic thing that can be said is that the council of financial regulators are aware of the problem and are trying to do something about it.

The third change was slowing global growth — and in particular the softer Chinese economy. Trading partner growth was nudged down a little — but it was small. The RBA said so in the SOMP.

It’s worth noting that Australia’s real trading partner problem was the prior tightening of Chinese policy — this was hurting steel demand. Thus, policy loosening in the Chinese property space and increased infrastructure spending may ultimately help Australia via the terms of trade.

This last point is worth dwelling on a little. Australia’s macro fortunes are largely determined by movements in the terms of trade. The transmission from higher terms of trade to wages and inflation has been broken since 2008, because prior excesses in mining investment and fiscal policy were being worked off … but these prior excesses have now been worked off. Mining investment has probably bottomed out, and recently high Iron Ore and Coal prices mean that we’re likely to see a budget surplus in the 2018/19 financial year. The budget assumption for Iron Ore is USD55, so the present 160% premium over the assumption will be very helpful.

Of course, none of this will matter if house prices continue to fall by 1%m/m — but the RBA won’t react to this until they see the consequences in consumption. That’ll take time.

Before that happens, we’re likely to see PM Morrison boost the size of income tax cuts when the 2019/20 budget is handed down on 2 April budget … and mining investment might even respond to the signal from higher spot prices!


  1. Thanks for the post – very timely. I largely agree. My only quibble would be that I see a higher ToT driving income, wages and employment more directly – without requiring tax cuts or a mining investment response. Of course, those reactions would help. Either way, the key question as you stress is to what extent the housing downturn pushes the other way. Would be it be accurate to describe your central forecast as not that far away from the RBA’s? Meaning fairly stable to slightly improving UnN, wages and inflation, and no changes to the OCR for 2019?

    1. how does the money get from Iron Ore and Coal to the broader economy? Who spends it? I’m a bit of a bear on housing, so i think that wins in the end and the RBA’s next move is probably a cut — but the RBA isn’t going to ease on housing until they see it either become a proper credit problem or feed into normal macro variables. Neither is happening just now, and both will take some time …

      1. Wouldn’t the money from a higher ToT come back via dividends and buybacks (or else more investment)?
        Going back, I don’t think there have been many times when the RBA has cut when the ToT was rising and didn’t subsequently fall (suggesting any cut was at least partly in anticipation of a weakening of a international environment). Maybe 2001 is an exception, but that may have been due to slowing growth in the 2H of 2000, which itself may have been GST-related and due to the policy error of over- tightening in 2000.

        1. that’s true. but i think that’s the weakest effect. BHP for example is listed in three places: Australia, the UK and South Africa. So buybacks are spread across those three venues. The Australian listing has large foreign ownership — so there’s substantial leakage.

  2. oh come on fiscal policy excesses worked off. you sound as bad as Sinclair Davidson ( or even John Cochrane) but you understand fiscal policy.

    Excess are borne out by rising inflation. We get crow=ding out. didn’t happen my friend.

    you have missed why the cash rate is still at 1.5%. The labour market is not reacting because it has de-regulated without you realising it.
    We are now copying the USA.

    Time for re-regulation.
    I think you are attempting to say Morrison has and continues to worsen the structural position of the budget.
    always good to read you.

    1. It is just a factual comment: recent terms of trade increases did not boost government spending as they were trying to swing the balance back toward positive.

  3. if you cut taxes because of rising tax revenue but do not cut spending you MUST worsen the structural poistion of the budget. Costello and Howard did it. Morrison is doing it. He did it as Treasurer and dong it in spades as PM.

    1. yes, i agree. that’s his plan. he’s hoping to have some money to return via tax cuts. the increase of the terms of trade should allow him to increase the size of tax cuts when the budget is handed down in April.

Comments are closed.