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The RBA refused to join the chorus of central banks who have decided to flag the possibility of policy tightening later this year.

Don't expect RBA to join policy tightening bandwagon

David Bassanese
5 July 2017

The Reserve Bank of Australia this week pointedly refused to join the chorus of other central banks who have decided over the past week or so to flag the possibility of policy tightening later this year. The RBA’s refusal to join the hawkish bandwagon was a surprise to many market traders – so much so that the $A dropped and bond yields fell following the RBA’s post-meeting policy statement.

Yet the RBA’s reluctance to follow the new global trend should be no surprise. After all, the shift in global growth dynamism in recent years – from China’s smoke stack industries to America’s Silicon Valley - is not overly conducive to Australia’s growth prospects. Iron-ore prices have seen their best days, and the growth of America’s tech giants is more a threat than saviour of Australia’s ailing media and retail stocks – not to mention their landlords in the listed property sector.

Australian economic growth and corporate earnings are likely to underperform global peers for some time. Accordingly, the RBA should and likely will lag the moves of other central banks – not only in the United States but also the United Kingdom, Canada and even Europe – to withdraw the emergency levels of policy stimulus that have more or less been in place in their economies since the financial crisis almost a decade ago. 

The great hope of the RBA is that the gradual re-normalisation of monetary policy settings in other parts of the world will help (finally) drag down the $A to more competitive levels. As I’ve long argued, with the mining boom over and the housing construction boom reaching a peak, only a notably weaker $A – barring major new fiscal stimulus from either the Federal or State Governments – will provide the next leg of growth impetus that the economy will desperately need over the next year or two. 

Indeed, the RBA suddenly appears a little less bullish on the economic outlook than it seemed only a month ago. In the past two post-meeting policy statements, the RBA clung to its confident prediction that economic growth would accelerate to “a little above 3%” over the next couple of years.  That confidence went missing in action in this week’s statement following the July policy meeting. The only comment the RBA could muster was that the economy “is expected to strengthen gradually”. 

What’s changed? I suspect the RBA is becoming a little less confident that wages growth is likely to pick up anytime soon – despite recent declines in the unemployment rate and reasonable job gains. Indeed, the international evidence increasingly suggests that wage growth is failing to accelerate in either the United States, Europe or Japan despite apparent growing labour market tightness. Concern over wages is apparent from the fact RBA Governor Phil Lowe, in a recent speech, amazingly seemed to cajole workers into exercising their apparent enhanced bargaining power and demand more from their employers.

Of course, the RBA’s concern is not with wage growth per se, but rather the risks that continued weak household incomes pose to consumer spending – which still accounts for just over half of all economic growth in the country. The weakness in consumer spending over the past two quarters has likely already undermined the RBA’s bullish growth expectations for this year, though there has been a feisty rebound in monthly retail sales (which are notoriously volatile) over the past couple of months. 

What’s more, the longer wages growth stay low, the more likely that inflation expectations will ratchet down (from around 2 to 2.5% to something less), which in turn will make it all the more harder for the RBA to achieve its 2 to 3% inflation target over the medium term.

All up, don’t expect the RBA to join the bandwagon of other central bank’s that are now trying to prepare their own financial markets for an eventual tightening in policy over the next six months or so. Although our official interest rates are at below-average levels, they remain ridiculously low in many other parts of the world – especially in Europe and Japan. What’s more, many other centrals banks took it upon themselves to buy up billions in their own government’s debt so as to force down bond yields also. 

Policy re-normalisation is much more pressing in these countries now that economic growth has improved and deflation fears have passed almost a decade on from the financial crisis. 

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