RBA Seen Holding Rate Ammunition Through 2017 Despite Weak CPI

(Bloomberg) -- Is Philip Lowe about to walk the talk?

Having spent the six weeks since he took the helm at the Reserve Bank of Australia laying the groundwork for tolerating weak inflation, money markets now expect the Governor to see it through and leave the cash rate unchanged Tuesday. Traders are even signaling the current record-low 1.5 percent may be the bottom of an easing cycle that began in late 2011.

“For the past five years, Australia's story has been about absorbing the negative income shock from falling commodity prices and rebalancing growth away from mining investment,” said Paul Bloxham, chief economist at HSBC Holdings Plc in Sydney. “This drag on national incomes is now in the past” and “the emphasis Governor Lowe has given to the ‘flexible' nature of the target suggests he is unlikely to feel compelled to respond to every CPI print.”

Outside inflation, Australia's economic growth and employment are holding up -- even if headline rates mask some weakness -- and commodity prices have rebounded. Lowe has indicated if growth was weak and unemployment rising, he would try to return inflation to its 2 percent to 3 percent target faster: in other words he would be prepared to reduce rates further.

Lowe's reluctance to cut again stems from a desire to avoid adding impetus to already high asset prices, particularly housing in Sydney and Melbourne, and encouraging further borrowing among already heavily indebted households. Treasurer Scott Morrison also said this month that he didn't detect much enthusiasm at the RBA for further easing.

While money markets ascribe about a 6 percent chance of a rate cut Tuesday and a maximum 42 percent probability of a reduction next year, economists are less convinced. Six of 28 surveyed by Bloomberg predict a cut tomorrow, and the median estimate is for borrowing costs to fall to 1.25 percent in the second quarter of next year.

Still Confident

Paul Brennan, chief economist at Citigroup Inc. in Sydney, is maintaining his call for a cut Tuesday, while acknowledging the “minuscule” market pricing for such a move. He said third-quarter consumer-price data released last week remained low and it shouldn't give the RBA any confidence that inflation is heading back to target. 

Brennan also cited a recent slump in full-time employment and the fact it was only a drop in participation that pushed the jobless rate down to 5.6 percent. If participation had stayed at its end of 2015 level, he estimates unemployment would now be at 6.5 percent. As a result, there's a lot of slack in the labor market and that “implies a harder challenge to raise inflation,” he said.

But then there's key trading partner China. The world's No. 2 economy expanded at 6.7 percent in the first three quarters -- smack in the middle of the government's planned 6.5 percent to 7 percent target. That's a far more positive picture than the one painted earlier this year and gives a boost to Australia, the most China-dependent economy in the developed world.

Fed Effect

Further help could come from the exchange rate. The Aussie has climbed more than 10 percent since mid-January as the Federal Reserve dithered over tightening and yield-hungry investors piled into assets Down Under. But with the market expecting the Fed to raise in December, the local dollar may begin to slide again. That would help currency-sensitive service industries like tourism and education and lift import prices that might boost inflation.

The RBA will also release its quarterly Statement on Monetary Policy on Friday, which contains updated economic growth and inflation forecasts. The board will be able to review those numbers at Tuesday's policy meeting.

“An implicit -- albeit mild -- easing bias will remain evident in the key macro forecasts, ” said Su-Lin Ong, head of Australian economic and fixed-income strategy at Royal Bank of Canada in Sydney. But “we expect the tone of the statement on Tuesday and the SoMP to be reasonably balanced and positive, highlighting near-trend growth and consistent with an RBA on the sidelines.”

--With assistance from Benjamin Purvis and Kimberley Painter To contact the reporter on this story: Michael Heath in Sydney at mheath1@bloomberg.net. To contact the editors responsible for this story: Nasreen Seria at nseria@bloomberg.net, Chris Bourke