RBA Holds Rate as Currency Seen Subduing Inflation, Growth

Australia’s central bank kept interest rates unchanged and warned a rising currency is expected to subdue inflation and weigh on the outlook for growth and employment.

The Australian dollar has surged more than 11 percent this year, hampering the Reserve Bank’s efforts to transition the economy to growth led by exports like education and tourism. That prompted Governor Philip Lowe to end 16 months of gentle cautioning that a rising exchange rate could merely "complicate" the handover.

For analysis of Tuesday’s RBA’s statement

“The higher exchange rate is expected to contribute to subdued price pressures in the economy,” Lowe said in his statement, the longest since 2013. “It is also weighing on the outlook for output and employment. An appreciating exchange rate would be expected to result in a slower pick-up in economic activity and inflation than currently forecast.”

The Australian dollar bought 80.14 U.S. cents at 4:47 p.m. in Sydney, little changed from 80.19 cents before the statement detailing the board’s decision to hold the cash rate at 1.5 percent. Traders are pricing in a 50 percent chance of a rate increase in July.

“The bank would be particularly concerned if the Australian dollar remains stubbornly high, should the terms of trade decline as the bank is currently expecting,” said Paul Brennan, chief economist for Australia at Citigroup Inc.

Lowe and his deputy, Guy Debelle, began to ramp up their rhetoric on the Australian dollar last month and have elevated the negative impact of its strength. Still, policy makers showed renewed confidence in the labor market -- following the biggest two-month full-time job gains in almost 30 years -- predicting that the jobless rate would “decline a little” over the next couple of years from the current 5.6 percent.

“The commentary around the labor market is still somewhat cautious despite consistently strong employment numbers,” said Bill Evans, chief economist at Westpac Banking Corp. in Sydney. “That is because concerns around wages growth remain, with the damaging feedback loop from low wages growth to weak consumption and business investment being of paramount concern.”

The RBA reiterated that wage growth remains low and will likely be so for some time yet. That, together with new entrants in the retail industry -- read Amazon.com Inc. -- are likely to keep inflation subdued, notwithstanding sharp electricity price increases.

One Year

The RBA has kept rates unchanged for a year and refrained from joining global counterparts in signaling plans to withdraw stimulus amid concern about weak wagesand tepid inflation. Its easing cycle began in late 2011 and was designed to cushion a transition away from mining to services and manufacturing, encouraging firms to hire and invest.

“The low level of interest rates is continuing to support the Australian economy,” Lowe said in his concluding paragraph. “Taking account of the available information, the board judged that holding the stance of monetary policy unchanged at this meeting would be consistent with sustainable growth in the economy and achieving the inflation target over time.”

But the RBA still faces a problem with low rates and property. The Sydney and Melbourne housing markets have shown bubble characteristics. While low interest rates encouraged construction and the hiring of former miners, they unleashed a speculative frenzy among real-estate investors looking to cash in on tax breaks.

The central bank has supported regulators’ moves to strengthen home-lending standards and discourage the use of interest-only loans by owner-occupiers and investors. Still, Sydney and Melbourne prices climbed 1.4 percent and 3.1 percent respectively in July.

Iron Ore

Meanwhile, iron ore has rebounded in recent weeks as mills in China benefit from the government shuttering capacity, helping absorb increased ore supplies from Australia and miners like Rio Tinto Group and BHP Billiton Ltd. The IMF last month reaffirmed its forecast that the world economy would expand 3.5 percent this year, up from 3.2 percent in 2016.

On the wage outlook, some economists are skeptical. They point out that Australia hasn’t yet reached full employment and it has high under-employment. There’s also the worry that, between slim pay packets and record household debt at 190 percent of income, as well as people putting aside less savings in order to make ends meet, the country could face a consumption crunch.

“The bank’s forecasts for the Australian economy are largely unchanged,” Lowe said ahead of the release of updated quarterly forecasts Friday. Over the next couple of years, the economy is expected to grow at an annual rate of around 3 percent, he said, adding the transition to lower levels of mining investment following that industry’s boom is almost complete.

“One source of uncertainty for the domestic economy is the outlook for consumption,” Lowe said.