The Forward View – Australia: March 2017

Financial stability considerations to keep RBA at bay

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  • A strong bounce-back in real GDP was confirmation that the contraction in Q3 was a temporary blip and did not indicate a more fundamental deterioration. Growth in Q4 was broad-based across expenditure categories and states, and occurred in conjunction with a strong bounce in the terms of trade and profitability owing to sharply higher coal and iron ore prices in the quarter, although labour income was weak yet again.
  • Real GDP growth is likely to be strong through most of 2017, with our forecasts showing a gradual improvement in domestic demand as the drag from mining investment diminishes and government infrastructure spending remains solid, while net exports (especially LNG) add significantly to growth. In addition, the NAB business survey is suggesting higher business conditions in recent months than for much of the second half of 2016, despite some pullback in February, and is also pointing to a near-term strengthening in employment. We are not as relaxed about the growth outlook in 2018 however, and continue to forecast a pullback as the contributions from LNG exports, temporarily higher commodity prices and residential construction fade, while household consumption remains constrained by weak labour income growth. Our year-ended growth forecasts pick up to 3¼% by Q3 2017, but then eases to 2¼% by end-2018.  
  • The RBA is becoming increasingly focused on financial stability considerations, particularly household balance sheets in the context of a re-acceleration in house price growth in Sydney and Melbourne amidst elevated levels of household debt. Recent comments from RBA officials raise the possibility that macro-prudential measures may be stepped up and we now consider a further rate cut as unlikely in this environment. We have removed our expectation of a 25bp rate cut in late 2017, although continue to flag the risk of further monetary policy easing at some point given our concerns about economic growth and the labour market in 2018.
  • As a result of our RBA view change, we are revising up our 2018 AUD/USD forecast slightly while maintaining our 0.70 end-2017 projection. A weaker AUD is still likely on a combination of further US interest rate-driven US dollar strength, lower commodity prices and potentially some deterioration in risk sentiment from current elevated levels.

For further details, please see the attached document.