By Guest Expert September 7, 2018

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3 Economic Developments that Explain the RBA’s Recent Decision

Property Investment
3 Economic Developments that Explain the RBA’s Recent Decision

Low inflation, weak wage growth and rising mortgage rates underpinned the Reserve Bank's decision to keep the cash rate on hold at a record low at this weeks meeting.

RBA Low inflation, weak wage growth and rising mortgage rates underpinned the Reserve Bank’s decision to keep the cash rate on hold at a record low at Tuesday’s meeting.

And given the economic landscape, they’ll likely be on hold for some time yet.

Most economists agree that when the RBA does eventually move, the direction will be up.

However, it’s worth noting that if the other major banks follow Westpac’s decision to increase its lending rates, the RBA may actually need to consider cutting the cash rate further before any tightening begins.

Following the announcement that the cash rate would stay on hold at 1.5%, the RBA repeated its typically upbeat view that, ”further progress in reducing unemployment and having inflation return to target is expected, although this progress is likely to be gradual”.

Beyond that, here are the three areas the RBA board will watch closely while pondering what direction their next move will be.

1. Property investors are withdrawing and first-home buyers are picking up the slack

Investors are retreating but are being replaced by more owner-occupiers, particularly first-home buyers (see graph).

The Reserve Bank has emphasised that weak investor credit growth is not just due to banks tightening their lending practices, it’s also because investors become more hesitant as prices fall in Sydney and Melbourne.

As investors have retreated, first-home buyers have entered the market in growing numbers.

First-home buyers now make up 18% of all dwellings financed, up from about 13% at the start of 2017.

This has been driven by state government incentives for first-home buyers, mainly in the form of stamp duty concessions, and also a slight improvement in affordability.

2. Wages keep growing by less than expected

Wages growth has remained subdued, growing at only 2.1% over the year to June.

Although still sluggish, this was the fastest annual rate of growth since 2015, suggesting wage growth may have bottomed out.

The Reserve Bank believes that “wages growth and inflation will pick up gradually over the next couple of years as the labour market continues to tighten”.

This would be a welcome development, but the Reserve Bank and Treasury have been expecting wage growth to pick up to about, or above, 3% for several years and it hasn’t eventuated.

The graph demonstrates how unreliable the RBA forecasts have been in terms of predicting the future outcome.

A number of factors have contributed to the continued subdued wage growth: elevated underemployment, worker concerns over technology and outsourcing, declining worker bargaining power and lower productivity growth.

3. The Reserve Bank is expecting lower inflation in 2018

The Reserve Bank recently updated its forecasts and expects inflation over the next six months to be lower than previously thought.

This is due to a number of one-off changes such as the new child care subsidy and a decline in energy prices.

By the end of 2020, the Reserve Bank expects inflation to be 2¼%, which is still below the mid-point of the Reserve Bank’s 2-3% target range. Inflation has been below 2½%since 2014.

A closer look at Tuesday's Reserve Bank interest rate announcement

Today’s interest rate announcement didn’t add much insight into the Reserve Bank ’s thinking because there were a number of public announcements in August.

interest-rate-cut-percentage These included the August Statement on Monetary Policy, the Statement to the House of Representatives Standing Committee on Economics and numerous speeches.

Governor Philip Lowe provided good insight into the Reserve Bank’s thinking in the address to the House of Representatives Standing Committee on Economics, where he outlined the four topics the Reserve Bank is following most closely: the outlook for global growth, the property market and household debt, wages and the inflation outlook.

In today’s statement, the key changes to the language were that wage growth has “picked up a little recently” and that the “improvement in the economy should see some further lift in wages growth over time, although this is likely to be a gradual process”.

The RBA also stated that, “the economy is estimated to have grown at an above-trend rate” in the first half of 2018.

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