At its first meeting for 2016, the RBA Board left the Overnight Cash Rate unchanged at a multi-decade low of 2%, as widely expected (see chart). There was little change in the communication from the last meeting's statement two months ago. It cited that global growth is lower than earlier expected, particularly in China and other emerging economies. Risk appetite has diminished somewhat and credit conditions for low quality corporates has tightened, although funding costs remain low for high quality corporates.
GDP growth came in below average in the second half of 2016, but business sentiment lifted to above average levels and labour market conditions continued to firm, reflected in a pick up in employment growth and a lower unemployment rate. Underlying inflation is expected to remain at 2% thanks to the prospect of still low growth in productivity adjusted wages (ie. Unit labour costs) and spare capacity in the global economy.
Against this backdrop, the RBA re-iterated that monetary policy needs to be accommodative. Macro-prudential policies are helping to contain risks in the housing market, reflected in a moderation of house price increases in Sydney and Melbourne, and a changing composition in lending towards owner-occupiers and away from investors.
The RBA identified two key developments it would monitor closely; whether the firming of labour market conditions would continue and whether the recent financial market turbulence points to prospects of weaker global and domestic demand. It maintained its easing bias, stating that the inflation outlook provides scope for further policy easing if deemed necessary.
The RBA appears to be content for the Australian economy to operate with a degree of spare capacity. It is clearly drawing some comfort from the improvement in labour market conditions, which is a welcome development. While increased labour demand has played a role here, I suspect that an expansion in the labour supply can help to reconcile strong growth in employment with the absence of wage pressures.
On face value, the renewed depreciation of the Australian dollar appears to be contributing to an easing of financial conditions. But on closer inspection, it seems to reflect the weaker global growth environment and US dollar strength. In the past five years, the Australian dollar has declined by 35% against the US dollar but by only 20% on a TWI basis (see chart). Moreover, based on the Economist magazine's updated Big Mac index, the US dollar is under-valued against only three other currencies.
Australian growth to remain stuck in the slow lane
The RBA is content for growth in the Australian economy to remain in the slow lane over the course of 2016 and is hoping that the non-mining sectors grow enough to ameliorate the effects of the slump in mining business investment. Evidente remains of the view that at least one more rate cut (and most likely two) is necessary to revive animal spirits in the corporate sector and boost household consumption. International developments might well force the hand of the reluctant rate cutter, notably more monetary stimulus from central banks in response to further deterioration in the global growth environment.