Saturday, February 07, 2015

Dire forecast led to Reserve Bank cut

The Reserve Bank board decided to cut interest rates on Tuesday after being presented with forecasts showing what would happen if it did not.

The revelation, in the latest Reserve Bank quarterly statement, suggests the bank's original economic forecasts were far worse than those released with Friday's statement.

The statement predicts "only modest" employment growth and a further rise in the unemployment rate. Its central forecast for economic growth in the year ahead has been marked down from 3 per cent to 2.75 per cent.

The fine print of the statement reveals that not only were the forecasts made less alarming by factoring in the interest rate cut announced on Tuesday, but also by factoring in a second cut in May and the chance of a third one a few months later.

The statement says the forecasts were "conditioned on the assumption that the cash rate moves broadly in line with market pricing as at the time of writing".

The market pricing assumed another cut in the Reserve Bank's cash rate from 2.25 per cent to 2 per cent in May and then an even chance of a further cut, to 1.75 per cent, in October.

The forecasting assumption is a change from the one used by the RBA in its previous statement in November which assumed a steady cash rate years into the future...

The current cash rate is the lowest since 1959. The cuts assumed in the RBA's statement would take it to its lowest since the bank was founded as the Commonwealth Bank in 1911.

Even factoring in those cuts the bank expects Australia's economic growth rate to slide to just 2 per cent in the March quarter. Taking into account the historical range of forecasting errors the bank concedes it could fall to 1 per cent. Beyond that it expects economic growth to recover climbing to 3.75 per cent by 2017, although it concedes it might still be as low as 2 per cent by then.

It expects the unemployment rate to climb to 6.3 per cent before falling, although it concedes it could climb to 7 per cent.

The RBA says the unemployment rate has been climbing at an gradual pace of 0.1 percentage points every three months for the past two and a half years.  It says despite the an increase in the number of people employed since then there has been no growth in the number of hours worked since late 2011, meaning there is less work for each person available to work than there was three years ago.

The bank says it is not expecting the government to boost the economy, predicting that public demand will grow "at a below-trend pace" over the forecast period.

It says mining investment will fall sharply over the next two years and that non-mining business will remain subdued until at least mid-2015.

Household spending growth should remain weak despite the lower oil price and lower interest rates, held back by low wage growth and a weak labour market.

The higher import prices resulting from the lower dollar had yet to feed through into retail prices because retailers were finding it difficult to pass on costs.

The bank was careful to say that although it was factoring in further interest rate cuts the assumption in its forecasts did "not represent a commitment" to those cuts. It might cut by less, or more, depending on how conditions developed.

In The Age and Sydney Morning Herald

As adjusted:

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