MNI 5 Things: RBA Says Higher Rate Appropriate At Some Point

--But No Strong Case For Near-Term Adjustment in Cash Rate

By Sophia Rodrigues

     SYDNEY (MNI) - Following are the five key observations we made from the

Reserve Bank of Australia's Statement on Monetary Policy published Friday:

     --The RBA didn't incorporate forward guidance in the May cash rate

statement but included in the full policy statement. "If the economy continues

to perform as expected, higher interest rates are, however, likely to be

appropriate at some point," the RBA said. It also added that "Notwithstanding

this, the board does not see a strong case for near-term adjustment in the cash

rate,"

     The tweak in forward guidance to add "at some point" suggests the RBA is

keeping open the possibility of raising the cash rate earlier than expected.

This would likely depend on the forthcoming budget and how the labor market and

in particular wage growth, performs versus expectation. On the other hand, the

RBA is also keeping open the option of delaying the hike if lending rates go up

in response to higher funding costs.

     --Both headline and underlying inflation forecast for June 2020 were

maintained at 2.25% which is the end period of published forecasts. However, the

balance for risks for inflation appear to be to the upside from retail deflation

and dwelling construction, and also the possibility that wage growth could pick

up quicker than expected. The RBA said outlook for retail prices depends on how

long the structural change underway in the retail sector continues to put

downward pressure on prices. While retailers continue to adopt various pricing

strategies, it is possible that the pace of downtrend in prices could be slower,

especially if the exchange rate remains week. The RBA has noted that despite a

modest depreciation in the exchange rate over the past year, import prices have

been little-changed. In case of dwelling construction, the RBA said the price of

building would depend on how the industry responds to competition for labor and

material inputs from the non-residential construction underway.

     --The RBA said GDP growth is currently around estimates of potential growth

in year-ended terms but the economy is not expected to encounter broad-based

capacity constraints for some time. The reason for this is because the RBA puts

lot of emphasis on spare capacity in the labor market and its view remains that

spare capacity will remain even until the end of forecast period. The RBA also

clearly indicated its expectation that unemployment rate indicating full

employment level could turn out to be lower than previously assumed.

     --The RBA had a detailed discussion on rise in money market rates and how

it impacts funding costs of banks, wholesale deposits, business lending, hedging

costs and also retail deposits. The RBA said that  "there have been few signs as

yet of mortgage rates changing in response to the increase in funding costs,"

but also noted that spread between major banks' lending rates and overall debt

funding costs is estimated to have narrowed recently.

     --One of the key risks for RBA's monetary policy is the possibility that

global inflation could be higher than expected which could prompt faster

tightening of monetary policy by central banks and lead to tightening in

financial conditions. For Australia, the risk here is via rise in funding costs

and if this happens in an environment where local inflation is subdued, it could

mean the cash rate would stay on hold for longer.

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

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