Reserve Bank leaves cash rate on hold

The Reserve Bank kept interest rates on hold at 1.5 per cent at Tuesday’s meeting, but the likelihood that the cash rate will be cut is increasing, with the central bank becoming less optimistic about the economy. Financial markets now believe there is an 80 per cent chance that the cash rate will be cut to 1.25 per cent by November this year.

Despite a shift in its forecasts, the RBA maintained the key line: “The low level of interest rates is continuing to support the Australian economy. Further progress in reducing unemployment and having inflation return to target is expected, although this progress is likely to be gradual”.

Although the unemployment rate remains low and jobs growth has been strong, recent economic data has mostly been weak and leading indicators suggest the economy will grow slowly in 2019.

There were few surprises in Tuesday’s commentary after a flurry of RBA communications over the past month: the RBA’s February Statement on Monetary Policy contained updated forecasts, RBA leaders appeared before Parliament and Governor Philip Lowe gave a wide-ranging speech in early February.

The RBA’s latest forecasts predict that the economy will grow more slowly

The RBA is less optimistic about the outlook for the economy than it was at the end of 2018. In the February Statement on Monetary Policy, the RBA substantially downgraded economic growth (GDP) and inflation forecasts for the next two years (see table). The RBA now expects GDP growth over the year to June 2020 to be 2.75 per cent, down from 3.25 per cent it forecast in November 2018. Much of this economic growth will be driven by strong population growth.

The RBA is also forecasting inflation over the next 12-18 months to be at or just below the central bank’s 2-3 per cent target band.

A string of weak data has contributed to a softer outlook for the economy. The construction sector is slowing, with building activity falling by 3 per cent in the December quarter. Building approvals, a leading indicator of future construction activity, were 28 per cent lower in the three months to January compared to same period the previous year. And the Housing Industry Association expects housing starts to decline from 226,000 in 2018 to 191,000 in 2019 and 180,000 in 2020, which would be the lowest rate of construction since 2013.

Consumer spending data has also been weak. The RBA sees weak income growth and falling house prices weighing on household spending as a growing risk to economic activity. Household spending accounts for about 60 per cent of economic activity, so lower spending has a big impact on the outlook for the whole economy.