Reserve Bank significantly lowers inflation forecast

Gareth Hutchens
The RBA’s admission it could take longer for inflation to rise has reinforced concerns about ‘lowflation’. Photograph: Jason Reed/Reuters

The Reserve Bank has conceded it could take longer than expected for inflationary pressures to build in Australia, meaning record-low interest rates could be here until 2019.

The admission has reinforced concerns about the scourge of “lowflation”, and comes weeks after John Fraser, the Treasury secretary, admitted being caught off-guard by Australia’s severe wages slowdown in recent years.

The RBA released its latest quarterly statement on monetary policy on Friday, with updated projections for GDP growth, unemployment and inflation.

Its projections for GDP growth for the next three years are largely unchanged. Growth is still forecast to be 2.5% in 2017, 3.25% in 2018, and 3.25% in 2019 (down slightly on the August forecast of 3.5%).

It is forecasting the unemployment rate will track sideways at its current 5.5% rate, before edging lower to 5.25% by the end of 2019.

But it has significantly lowered its inflation forecasts for the next few years.

Three months ago, it was forecasting underlying inflation would rise to 2% by the end of 2018, but it now expects that won’t happen until the middle of 2019.

It had also previously forecast underlying inflation would rise to 2.5% by June 2019, but it now expects inflation will only be 2% by the end of 2019.

The significant downward revision prompted Westpac analyst Robert Rennie to say: “That feels like lowflation to me?” Lowflation refers to persistently low inflation that refuses to respond to relative price adjustments, such as falling unemployment.

The Reserve Bank traditionally does not consider lifting interest rates until inflation is sitting within its 2% to 3% target band.

Bill Evans, Westpac’s chief economist, said the downward revision means there is “considerable doubt” about the timing of the RBA’s next interest rate hike.

“We are now assessing a central bank which is expecting that it will undershoot its core inflation target for another year, and that even one year out, inflation will still be at the bottom of the target zone,” Evans wrote in a note to clients on Friday.

“Recall that in May 2016, when the bank was forced to lower its underlying inflation forecast to 1.5%, it immediately cut rates by 0.25%.

“It is uncomfortable for a central bank to be consistently undershooting its target, and it would be surprising if it felt the need to tighten policy at a time when inflation is below its target.

“We are not changing our view that rates will remain on hold in 2018 and 2019, but we have always been uncomfortable that the central bank’s forecasts were implying that it was expecting that it would be raising rates in 2018. These forecasts no longer portray a central bank that expects to raise rates.”

Former RBA official Stephen Grenville wrote on Friday that given the significant structural changes that have occurred in developed economies (where inflation has barely lifted, even though unemployment rates have fallen) central banks must start considering a wider range of indicators beyond inflation.

The RBA has remained cautious on wages growth but says there are signs of a turning point.

It says liaison with business found there were skills shortages for IT and construction workers, and the frequency of wage freezes in the mining industry has been declining.

Paul Bloxham, HSBC’s chief economist for Australia, said once the RBA is convinced that wages growth is past its trough, it is likely to begin withdrawing its highly stimulatory monetary policy setting.

“Keep in mind, wages growth is a lagging indicator, so by the time it arrives, everything else has usually picked up pace,” Bloxham said.

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