RBA Sees Weaker Currency Fueling GDP Growth, Inflation


gsr-356468The Reserve Bank of Australia raised its economic growth and inflation forecasts, reflecting a weaker currency, and reiterated its shift to a neutral policy stance.

“Over the past few months, there have been further signs that very stimulatory monetary policy is working to support economic activity,” the RBA said in its quarterly monetary policy statement in Sydney today. “The board’s view is that a period of stability in the policy rate is likely.”

The central bank projected core inflation of 3 percent in the year ended June, half a point higher than seen three months earlier, and 2.25 percent to 3.25 percent through December 2014, a quarter-point increase. It expressed uncertainty over what drove a price pickup last quarter and said it expects inflation to be consistent with its target over the forecast period.

The Aussie fell about 5 percent in the past three months, among the worst performing Group of 10 currencies, easing pressure on industries like tourism and aiding the RBA’s effort to rebalance the economy away from resource investment. The currency traded at 89.29 U.S. cents at 12:19 p.m. in Sydney, from 89.46 cents before the statement was released.

Gross domestic product is forecast to rise by 2.75 percent in the year to June and 2.25 percent to 3.25 through December, “primarily owing to the lower exchange rate, which is expected to boost exports and restrain imports,” it said. Those forecasts are up from November’s estimates of 2.5 percent growth in the year to June and 2 percent to 3 percent for the 12 months to December 2014.

Thing of Past

“Rate cuts are a thing of the past, largely thanks to the lower Aussie pushing up inflation and improving domestic demand,” said Katrina Ell, an economist at Moody’s Analytics in Sydney. “Our long-standing view is that rates will remain on hold until the second half of 2014, when gradual normalization will begin.”

The RBA kept rates unchanged at 2.5 percent since August, after 2.25 percentage points of cuts starting late-2011 that drove home prices higher and spurred a pickup in approvals for residential construction.

“Dwelling investment is expected to grow quite strongly over the forecast period,” the RBA said. “Building approvals have increased sharply in recent months and other forward-looking indicators, such as loan approvals and first home owner grants for new construction, remain at relatively high levels.”

Currency Boost

The central bank said today that the lower exchange rate is expected to add about half a percentage point to underlying inflation over 2014 and 2015. It said the subdued outlook for the labor market is expected “to exert downward pressure” on wages and inflation.

The Aussie has fallen about 15 percent since a peak in April last year, with only fellow commodity producers Brazil and South Africa performing worse among major currencies. The central bank sought to talk down the currency late last year to ease pressure on exporters, an effort boosted by the Federal Reserve’s decision to begin tapering bond purchases.

“Lower levels of the exchange rate will assist in achieving balanced growth in the economy,” the RBA said. In a section on risks, it said “with the terms of trade expected to decline, the exchange rate could decline further over time.”

Australia’s economy has been boosted by the biggest mining investment boom in a century, which is now waning. The RBA said “while bank liaison suggests that the peak in mining investment has passed, the expectations component of the ABS capital expenditure survey, which tends to be relatively imprecise guide to firms’ realized spending, continues to point to some growth in mining investment in 2013/14.”

China Strength

The RBA said China, Australia’s biggest trading partner, is likely to grow about 7.5 percent this year, similar to 2013. It expects year-average growth in Australia’s major trading partners to be 4.5 percent, a little higher than in 2013.

Traders are betting policy makers will add 18 basis points to the cash rate over 12 months, swaps datacompiled by Credit Suisse Group AG showed.

“The risk is that inflation will hit the top end of the RBA’s target given the likely weakening in the Aussie dollar as the unwinding of quantitative easing in the U.S. continues over 2014,” said Martin Whetton, an interest-rate strategist at Nomura Holdings Inc. in Sydney.

A key determinant ahead will be the labor market. Australian employers unexpectedly cut jobs in December by 22,600, capping the worst year of full-time losses since 1992.

Wage Restraint

“Reflecting elevated concerns of households over job security, relatively low inflation expectations and pressures for firms to contain labor costs, the forecast profile for wages has been revised a little lower over coming quarters,” the central bank said today.

Business and consumer confidence have revived since the Sept. 7 federal election. Budget deficits confronted by the federal and state government indicate fiscal tightening will weigh on growth.

“The fiscal consolidation foreshadowed by state and federal governments implies the weakest period of growth in public demand for at least 50 years,” the RBA said. “With below-trend growth in the economy, it is possible that governments will not restrain spending growth to the extent assumed.”