Thursday 07 April 2016 by Opinion

RBA decision and inflation

The RBA's cash rate has remained the same, although direction for the year ahead is dependent on how the global economic direction unfolds


The RBA met expectations and didn’t change their cash rate on Tuesday.  The direction for the rest of the year depends on whether the economy can preserve recent positive momentum, in which case rates are likely to remain on hold for some time as the global economic direction unfolds. Cash rates could also be affected if the economy is pulled down by global factors such as slower growth in China, or the ongoing currency wars pushing up the AUD and weakening our exporters. 

Recent data pointing to a weakening in response to global pressures includes: wage growth, inflation, residential property construction, and retail sales.

Wage growth and rising inflation are related signs of a strengthening economy.  Rising prices across an economy indicates that demand is exceeding supply for inputs that are widely used, such as wages.  When wage growth rates increase, it is an early warning sign that employers have to compete for labour; that employment is nearing “full”.  Comparatively, when wage growth is low, it becomes a predicator of weakened competition of labour. This suggests that the economy is not expanding strongly enough in order to create new jobs to keep pace with population growth. 

Wage growth was last released for the December 2015 quarter and is not provided again until late May.  However, inflation is measured monthly via the Melbourne Institute Monthly Inflation Gauge.  This measure showed inflation in March at 0%, bringing the past 12 months to just 1.7%pa, well below the 2-3%pa target rate for the RBA.

According to the most recent data, retail spending in February showed nil change on the previous month, falling well below expectations of 0.4% growth.  Retail spending accounts for 56% of Australia’s GDP and was a major contributor to last year’s 3%pa growth overall. 

Inflation, wage growth and retail spending are not volatile factors in an economy; they tend to “creep”.  On the other hand, construction is the big swing factor.  Construction, particularly for investment properties such as inner city units, is highly volatile and subject to bubbles.  Construction of new houses in Australia has risen by just 4% in total in the past 10 years, while new units have risen by 105%, including a 50% increase in the past two years alone.  Subsequently, the signs of a sudden downturn in Brisbane and Melbourne are looming.  Wage growth in the construction sector has also dropped dramatically, from its long term average of 4-5% prior to 2012, to 3-4% post-mining investment boom, then another sudden drop to 1.5% by the end of 2015.  This is the same level of wage growth as the mining industry and construction’s lowest wage growth on record. 

Remembering that a central bank’s role is to maximise employment while maintaining inflation at their target, inflation at just 1.7%pa and indications of slow jobs growth ahead, combined with a high AUD, will weigh heavily on the RBA’s decision process.  This raises the chances of a fall in long term rates in Australia and therefore a fall in the AUD.