The AUDUSD has faded overnight gains and was trading near session lows after the RBA kepts its interest rate at 1.5% as expected and previewed last night, however in an echo of last week's comments from Lowe, the central bank flagged that a stronger AUD was expected to contribute to subdued price pressures and was weighing on the outlook for output and employment and would result in a slower pick-up in economic activity and inflation than currently forecast.
The kneejerk reaction after the statement was for AUDUSD to gap lower, followed by a prompt rebound as traders digested the perceived ongoing weakness of the US dollar and the generally upbeat tone of the statement. It has since drifted lower, however, with the pair back under 0.80 as the dovish warnings prevailed coupled with several banks pushing back their expected first date of the first RBA rate hike (see below).
Overall, there were three noteworthy changes in the Governor's Statement as flagged by SocGen.
- Most relevant was a new paragraph addressing the appreciation of the exchange rate and its (undesirable) consequences.
- Secondly, the labour market is no longer characterised as mixed and described in positive terms.
- And lastly, the tightening of credit conditions and higher rates for housing investors are acknowledged as having taken place, rather than as something that could happen.
The change in tone on the exchange rate, combined with our constructive view on the AUD, was sufficient to change SocGen's forecast for RBA policy, and as a result the bank is pushing the date of the first expected rate hike out by six months from February 2018 to August 2018.
Some more details from the French bank:
RBA unhappy about the stronger exchange rate
For many months, the RBA Governor's Statement limited itself to a simple sentence as regards the Australian dollar's exchange rate: “An appreciating exchange rate would complicate this adjustment” - the adjustment being economic transition following the mining investment boom. However, today's statement went much further, and marked a clear change of tone and shift in concern. It is worth repeating the paragraph in full:
“The Australian dollar has appreciated recently, partly reflecting a lower US dollar. The higher exchange rate is expected to contribute to subdued price pressures in the economy. It is also weighing on the outlook for output and employment. An appreciating exchange rate would be expected to result in a slower pick-up in economic activity and inflation than currently forecast.”
Hence, the RBA is making it quite clear that the exchange rate has again become an important consideration in deciding the policy stance. The RBA is also hinting that a strong exchange rate implies either a looser policy stance or maintaining the current accommodative stance for longer. In other words, while not directly attempting to talk the currency down, the RBA is clearly establishing a quite direct link between the exchange rate and monetary policy, thus attempting to influence interest rate expectations and thereby the exchange rate. Consistent with this, the comment on commodity prices was also changed notably from “The rise in commodity prices over the past year has boosted Australia's national income” in July, to “Commodity prices have generally risen recently, although Australia's terms of trade are still expected to decline over the period ahead”.
As mentioned above, this rather radical change in tone is, in our view, sufficiently significant to make us change our view about the course of monetary policy in Australia, and push out our forecast on the timing of first rate hike by six months from February 2018 to August 2018.
RBA even more upbeat about the global economy
The language around the state of the global economy was upgraded a bit further. Conditions are judged to be “continuing to improve” and growth in the key economy for Australia, China, is seen to have “picked up a little”, rather than growth just being supported. Also, the RBA writes that “labour markets have tightened further”, dropping the qualifier “in many countries”.
Forecasts for Australian economy largely unchanged and optimistic
“The Bank's forecasts for the Australian economy are largely unchanged” is how the RBA described the discussion of the latest quarterly forecast round which will be published in Fridays Statement on Monetary Policy (SoMP). This was no surprise. Although GDP growth in 1Q was a bit weaker than predicted in the May forecasting round, momentum in 2Q appears to be a bit stronger than expected, so the near-term outlook should be roughly identical. And given that underlying inflation was right in line with the forecast, the near-term inflation forecast should be largely the same as well. That said, the about-5% increase in the trade-weighted exchange rate assumption underlying the forecast imparts a downward bias to both the growth and inflation forecasts.
That said, a subtle change in the description of the growth outlook suggests an upward adjustment. According to today's statement, “Over the next couple of years, the central forecast is for the economy to grow at an annual rate of around 3 per cent”, whereas in May that sentence was “Growth is expected to increase gradually over the next couple of years to a little above 3 per cent”. This could just reflect the fact that the forecast is rolled out one quarter (and a big growth-boosting base effect in 3Q), but it is a notable change. The fan charts and forecast ranges in the SoMP will tell us more. The view on investment prospects in the non-mining sector also sounds more upbeat, and residential construction is also “forecast to be maintained for some time, before slowing”.
Labour market assessment clearly upgraded
After four months of strong employment growth and some modest declines in the unemployment rate, the labour market is no longer being characterized as “mixed”, but in more positive terms. However, the view that “wage growth remains low and this is likely to continue for a while yet” was maintained, and hence this does not appear to stand in the way of a loose policy for another year.
Housing market concerns apparently less acute
For some time, the RBA's key concerns have been a weak labour market and a hot housing market raising financial stability concerns. This has not gone away, given that “Growth in housing debt has been outpacing the slow growth in household incomes”. However, despite some evidence that house prices are reaccelerating, the RBA states that “there are some signs that these conditions [of briskly rising housing prices] are starting to ease”. Moreover, the fact that higher interest rates for housing investors and some tightening of credit conditions are now a reality rather than a prospect, also suggests reduced concerns.