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RBA to hold on home loan interest rates

The Reserve Bank Board meets this Tuesday. No one could possibly be expecting any change in policy to come from his meeting. The key conflicting issues for the RBA will be the outlook for the global economy and the contagion of  the European turmoil back to Australia. The key links that will be most prominent will be the impact on business and consumer confidence; impact on funding costs for banks which might affect cost and availability of credit; impact on Asia's exports; and the direct impact on global growth forecasts of a Europe which now seems likely to see a contraction in domestic demand in 2011.

The key will be whether the RBA is inclined to lower its growth forecasts for Australia in 2011 and 2012. At present the Bank is forecasting GDP growth of 3.75% in 2011 and 4% in 2012. It assesses trend growth as 3.25%. A central bank which has rates at neutral; the unemployment rate only 0.2% above the NAIRU (rate below which inflation pressures become apparent); and growth expected to be comfortably above trend should have a clear tightening bias. If the Bank is revising down its growth rate forecast for next year back from 3.75% to, say, 3% then with a growth forecast slightly below trend there would be no pressing need to move rates away from neutral.

Inflation trends will also be important for policy. If, for instance, the Bank finds that with the release of the June quarter CPI on July 28 underlying inflation is printing at 0.8%qtr then it will be telling the Bank a disturbing story about inflation trends. The low point of inflation in the cycle is printing 3.2%, (6 month annualised) – an unacceptable position for a Bank seeking to hold inflation within the 2–3% range on average through the cycle. However, if it was

to significantly revise down its growth forecasts for 2010 and 2011 it could reasonably argue that 2010 was not the low point in the inflation cycle and could buy some time. For all these reasons we will be closely watching the Governor's Statement to assess whether the Bank is lowering its growth profile. One area where we think the Bank will not be disturbed by current global events is China. Like ourselves we think the RBA would see the current loss of momentum in some Chinese lead indicators as being consistent with growth moving back from an unsustainable 12% to a sustainable 9%. The Bank may be inclined to raise its forecast for mining investment following the announcement of the revised mining tax. With more attractive depreciation allowances and maintaining some of the positive (from the miners' perspective) aspects of the RSPT, we see this development as unambiguously positive for growth.

Source Bill Evans, Westpac Chief Economist