REPEAT: MNI: Dnside Risk But RBA Likely to Hold For Longer

Repeats Story Initially Transmitted at 00:38 GMT Feb 9/19:38 EST Feb 8

By Sophia Rodrigues

     SYDNEY (MNI) - The Reserve Bank of Australia's forecasts show underlying

inflation below the mid-point of the target band until the end of the forecast

period thus pointing to monetary policy being on hold for longer.

     Based on forecasts alone, there appears to be still some downside risks to

the cash rate especially if things don't play out as the RBA expects but

continued patience from the RBA means a more likely scenario is of the rate

staying on hold for the rest of this year, and possibly longer.

     There are several uncertainties to the RBA forecast but the most important

one is around estimates of full employment because that is key to acceleration

in wage growth, and thus to inflation.

     The RBA said the gradual pickup in inflation is based on assumption that

spare capacity in the economy will decline as GDP growth picks up to be above

potential and the economy moves closer to full employment. "This is expected to

see labor costs put more upward pressure on inflation."

     But it has also admitted that there is "always uncertainty around estimates

of full employment, the point at which wage growth might start to build." 

     The concern around this has increased given the experience of a number of

countries where declining unemployment rates accompanied by subdued wage growth

led to estimate of the level of unemployment rate to be revised down.

     "The experience of low wage growth in those countries with tighter labor

markets suggests that structural factors such as technological change and

globalization, have also had an important bearing on wage outcomes and could

continue to do so for some time yet," the RBA said.

     In the quarterly Statement on Monetary Policy published Friday, the only

significant change was a cut in unemployment rate forecast to 5.25% in June 2018

compared with 5.5% before. Growth and inflation forecasts were left untouched

until December 2019. For June 2020, which is the extended forecast period, the

RBA is expecting growth to ease slightly to 3%, headline inflation to remain

steady at 2.25% but underlying inflation to pick up to 2.25% from 2.0% in

December 2018.

     Still, the underlying inflation forecast would fall short of the mid-point

of the RBA 2% to 3% target band. Governor Philip Lowe signalled in a speech

Thursday that the RBA is targeting the mid-point of the target band, rather than

just within the target band.

     Apart from wage growth, the RBA has pointed to other factors that could

weigh on inflation. "The combination of weak discretionary spending and

continued retail competition has seen a decline in consumer durable prices over

recent years. While consumption growth is forecast to pick up this year, it is

expected that the arrival of new entrants in the retail sector will continue to

put downward pressure on some retail prices over the next few years," the RBA

said.

     The RBA also pointed to the behavior of inflation expectations and exchange

rate movements as other key uncertainties as far as the inflation outlook is

concerned.

     An important addition was discussion of risks surrounding the housing

market. The RBA warned that if housing prices were to fall significantly, it

would hurt household consumption and dwelling investment, which would in turn

affect employment in the construction sector and state government revenues.

     The RBA also reminded of the risks to consumption growth from highly

indebted households. "A highly indebted household sector is likely to be more

sensitive to changes to income, wealth or interest rates," the RBA said.

     There was commentary on the upside risks too, with the most noteworthy one

being the effects of stronger global growth on the Australian economy. This

might happen via direct demand for Australian non-resource exports as well as

depreciation of the exchange rate which may be the more important factor, the

RBA said. 

     A downside risk would be scenario where there is a large increase in

long-term interest rates in the advanced economies that would lead to increase

in market volatility and financial market disturbance in emerging markets, thus

dampening growth prospects.

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