ANALYSIS: RBA's Optimism Masks Key Risks From H'Hold Spending

By Sophia Rodrigues

     SYDNEY (MNI) - Despite the headwinds from a higher exchange rate and

cash-rate rise built into forecasts the Reserve Bank of Australia presented one

of its most optimistic forecasts for the economy -- slightly lowering the growth

forecast in the near-term but raising it to above-trend growth in the latter

part of forecast period.

     The RBA also raised its headline inflation forecast for 2018 while leaving

underlying inflation forecasts unchanged.

     Contrary to what many expected the risk to the forecast doesn't come from

the current elevated level of the exchange rate but rather from any future

gains. 

     "It is possible that the Australian dollar could appreciate further which,

if sustained, would be expected to result in a slower pickup in economic

activity and inflation than currently forecast," the RBA said.

     The RBA said that based on historical relationships a 10% appreciation of

the trade-weighted exchange rate that is not associated with higher commodity

prices would be expected to lower inflation by a little less than half a

percentage point over each of the following two years. Output would be expected

to be lower by 0.5% to 1% in around two years, it added.

     Key to the updated forecasts is continued expectation of a "bit above

average" growth in household consumption -- an assumption that appears

optimistic if any of the several headwinds to households detailed by the RBA

come to pass.

     This is the main reason why the RBA cited household spending as the main

source of uncertainty for its forecasts.

     "Domestically there is the risk that household spending growth could be

more constrained than expected by low real wage growth and high debt levels,"

the RBA said.

     Interestingly, the RBA nominated "future" exchange rate movements among

"other key sources of uncertainty" for the domestic economic and inflation

outlook along with the strength of recovery in nonmining investment and how

quickly wage growth responds to a decline in spare capacity in the labor market.

     Supporting the RBA's growth forecast is also "reasonably strong government

spending" that has been built into the forecast which reflects the significant

pipeline of public infrastructure work -- though the RBA pointed out that the

timing of expenditures on projects can be hard to predict.

     There appears to be a downgrade to the forecast for dwelling construction.

The RBA said contribution to GDP growth from dwelling investment over the

forecast period is expected to be minimal. For this, too, the RBA cited downside

risk if apartment construction approved mainly in the eastern states do not

commence because of weakness in prices.

     If this risk comes to pass, it could hurt household spending too, the RBA

said.

     The RBA's assumption for growth in household consumption is mainly due to

expectations that total hours worked would continue to increase and employment

would continue to increase.

     "However, ongoing expectations for low real wage growth remain a key

downside risks for household spending," the RBA said.

     Another risk is that the recent sharp increase in price of utilities could

have a larger effect on the consumption decisions of lower-income households,

the RBA said.

     Consumption growth could also be affected by large, unexpected rises or

falls in housing prices. At the same time, elevated debt levels remain a risk

because households would choose to pay down debt faster and cut their

consumption.

     The outlook for headline inflation is slightly higher versus May to reflect

an upward revision to expected utilities prices. The RBA also expected this to

have some indirect effect because it would raise input costs of businesses,

though competitive pressures could limit their ability to pass on costs.

     The RBA continues to expect wage growth to pick up gradually over the next

few years and downward pressure from heightened retail competition.

     The RBA has also factored in the effect of the appreciation in the exchange

rate since May. If sustained, this will put further downward pressure on retail

prices over the year ahead. Low rent is another factor keeping inflation low.

     Among the risks to inflation the RBA cited uncertainty about the extent of

spare capacity in the labor market and how employment-intensive future GDP.

     The RBA also cited subdued core inflation in many economies as a downside

risk. 

--MNI Sydney Bureau; tel: +61 2-9716-5467; email: sophia.rodrigues@marketnews.com

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