Insight: RBA Closely Watching Inflation Expectations, Dovish Bias Real

• Published on
• 06 Nov 2019, 12:00 AM

By Sophia Rodrigues

The Reserve Bank of Australia left the cash rate on hold to assess the impact of recent cuts but is aware of several risks that could push them to lower the rate again.

The dovish bias signalled in the cash rate statement on Tuesday when the RBA reiterated “the Board is prepared to ease monetary policy further if needed” is thus very real and could translate to a cut in the next few months.

INFLATION EXPECTATIONS

One data the RBA is closely watching is inflation expectations because of worry that sustained period of below-target inflation would lead to unanchoring of inflation expectations.

In the August Statement of Monetary Policy, the RBA noted some measures of inflation expectations had declined a little.

In particular, the RBA pointed to decline in long-term market-based measures of inflation expectations that were at their lowest since 1992.  Since then the break-even 10-year inflation rate implied by the difference between 10-year nominal bond yield and 10-year inflation indexed bond yield dropped to a low of 1.3% in September, and fell further in October before slightly rebounding towards 1.4% currently.

The RBA also noted that survey-based measures of inflation expectations had eased slightly or been little changed but remained consistent with the medium-term inflation target.

In September, consumer inflation expectations one-year ahead as measured by Melbourne Institute fell to 3.1% which was the lowest since June 2015. However, the recent survey showed a rebound to 3.6% in October.

The RBA may be particularly watchful of other survey-based measures which were very close to the lower bound of the RBA’s target range, so any decline from there would be worrisome.

Inflation expectations are important because they affect wage-setting and price-setting behavior, and both are important for the RBA to achieve the inflation target.

In the cash rate statement Tuesday, the RBA repeated that wages growth remains subdued and is expected to remain at around its current rate for some time yet. And therefore a further gradual lift would be a welcome development.

HOUSING CONSTRUCTION

The RBA’s another worry relates to housing construction which was noted in Tuesday’s statement. In August the RBA forecast a 9.0% y/y decline in dwelling investment in Q4, 7.0% decline in Q2 of 2020 and 3.3% fall in December before a small rise to 0.4% in Q2 of 2021.

While these forecasts could improve in the next set of forecasts due on Friday ,based on expectation that rising housing prices could lead to more construction, there is still an element of uncertainty.

The RBA is hoping dwelling investment would provide an upside risk to growth but is unsure whether there is enough in the pipeline to support growth.

Apart from these uncertainties, household consumption and the labor market will continue to be among the key data the RBA would be monitoring closely in coming months. Any significant weakness in the labor data could trigger a cut as soon as December, especially if it coincides with an upward pressure on the Australian dollar caused by global factors.

--Email: sophia@centralbankintel.com