The new forecasts will essentially be a re-calibration of the numbers given the recent run of weaker economic data. They do not constitute a shift in the underlying narrative that the Australian economy is well placed to continue to expand over the next few years.
The move to neutral forward guidance reflects an accumulation of downside risks to both the Australian and international economies over the past few months.
What is new is that there is now a credible scenario right in the mix of the RBA’s thinking that has the economy weakening significantly over the year ahead.
The focus is the labour market. If the economy is generating jobs and income growth rates are lifting, the RBA is content to stick with the glass-half-full approach to the economic outlook.
The risk is that the rate of growth of consumer spending falls to a point where business react with lay-offs and a retrenchment of investment plans. A looming Federal election heightens this risk somewhat.
Evidence is emerging that the big falls in Sydney and Melbourne property values are spilling over to the rest of the economy. We are seeing this with sales of luxury cars and household goods falling in recent times.
Business confidence, particularly in the economic outlook, has softened over the past six months. What is most alarming has been the collapse in residential building approvals. While a lower rate of building will eventually help stabilise house prices, in the meantime it could result in lower economic activity and most importantly, lower employment.
But the weak run of data hasn’t been enough to get the RBA to change their central case view.
It is the intention of business to continue to invest and hire staff that lies at the centre of the RBA’s positive central case view of the economy. The latest The Executive Connection CEO Confidence survey which covers the critical SME segment highlights this point.
While business perceptions of the economy have deteriorated in the past six months, leaders remain optimistic about their own prospects and plans. This is borne out in several business confidence surveys and the ABS capital expenditure intentions survey and was duly noted by the Governor in his speech.
For the RBA, it is global risks that are the most prominent threat to Australia’s economy, and the least predictable. The governor is clearly worried that the populist political response to stagnant living standards in the US and Europe will only make matters worse. But all they can do is monitor developments.
You get no sense that the governor expects a much weaker world economy to emerge in the months ahead, referring to the IMF forecasts for trend like growth of 3.5 per cent over the next two years. But global challenges, not least the financial issues bubbling away below the surface in China, are reason enough for the RBA Board to keep Australian monetary policy accommodative for the time being.
A shift from a tightening bias to neutral guidance could be viewed as a stepping stone to an eventual easing of monetary policy. The cyclical nature of economic activity supports this view. Most commentators and financial markets will likely run with this interpretation, particularly given the recent run of weak domestic economic indicators.
But the economy is operating in unusual ways since the financial crisis and the typical cyclical dynamics may not be as reliable as they once were. Right now, it is the housing adjustment, largely contained to Sydney and Melbourne, that could be temporarily holding back economic growth. It is still not clear that it will de-rail the broader economic expansion.
The fact that the housing adjustment is happening against a backdrop of falling unemployment and low interest rates gives some credence to the view that the economy can ride this out without a policy response from the RBA or the government. It also appears to be the key judgment that is keeping the RBA’s glass half-full.
Warren Hogan is the industry professor at UTS Business School.
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