RBA decides to leave rates on hold – but for how long?

Australia’s Reserve Bank board has taken a punt that it can live with lower inflation for a while and kept official interest rates on hold at the record low of 1.5%.

With a live Federal election campaign underway and an admission that inflation will not be back in its target band of 2-3% before 2020, the RBA decided to keep rates on hold and keep a very close eye on unemployment.

The decision to keep rates stable surprised some economists who thought the shock inflation reading of zero for the first three months of the year would push the RBA into cutting rates to inject a bit more life into the sluggish economy.

Many still think a rate cut is inevitable but that it has now been pushed into the coming months, leaving rates steady for the longest time in Australian history since a month after the 2016 election.

Any unemployment rise likely met with rate cut

In announcing the decision, RBA Governor Dr Philip Lowe stressed that board would be “paying close attention” to the labour market – virtually guaranteeing that any rise in unemployment would lead to a rate cut.

Dr Lowe’s statement also stressed that the RBA was keeping a close eye on developments in the housing market and wages growth for signs that a rate cut was required.

“The main domestic uncertainty continues to be the outlook for household consumption, which is being affected by a protracted period of low-income growth and declining housing prices,” said Dr Lowe.

House price falls continuing

He said the house price adjustment was continuing, with price falls resulting in property investors becoming scarce following the double-digit price falls in the big markets of Melbourne and Sydney.

“The demand for credit by investors in the housing market has slowed noticeably as the dynamics of the housing market have changed,” he said.

“The inflation data for the March quarter were noticeably lower than expected and suggest subdued inflationary pressures across much of the economy.”

Inflation pick up will be slow

Dr Lowe said that over the year, inflation was 1.3% and, in underlying terms, was 1.6%.

Inflation was expected to pick up but only gradually with underlying inflation predicted to be 1.75% this year, 2% in 2020 and a little higher after that, with the recent boost in petrol prices expected to help run up this year’s numbers.

He said the global economic outlook “remains reasonable, although the risks are tilted to the downside’’.

“Growth in international trade has declined and investment intentions have softened in a number of countries. In China, the authorities have taken steps to support the economy, while addressing risks in the financial system. In most advanced economies, inflation remains subdued, unemployment rates are low and wages growth has picked up.’’

Dr Lowe said the Australian labour market remained strong but there had been “little further progress in reducing unemployment over the past six months’’

He said unemployment was expected to remain steady at around 5% before falling 4.75% in 2021 and that wages growth should gradually improve.

On housing, Dr Lowe said that the downward “adjustment’’ in established housing markets is continuing, after earlier strong growth and conditions remained soft and rent inflation low.

RBA hold comes amid Trump trade threats

The RBA decision to leave rates on hold comes at an interesting time for global share markets, which have been volatile since US President Donald Trump took a tough negotiation stance with China in trade talks.

While the talks are ongoing, President Trump said the US now planned to raise tariffs on a range of Chinese goods on Friday, accusing Beijing of backing away from commitments it had already made during negotiations.

The high wire negotiating tactics on trade buffeted US stocks before they recovered and sent shivers through world markets as well.

Here in Australia, the ASX 200 initially tracked higher on Tuesday on the back of the US share market recovery but then slipped away as soon as the RBA hold decision was announced, eventually closing up just 12 points or 0.19% to 6,295.7 points.