The Reserve Bank of Australia forecast below-trend growth and rising unemployment in 2014 as resource investment drops and renewed currency strength drags on the economy, leaving open the chance of lower interest rates.
The forecast “reflects the substantial fall in mining investment, planned fiscal restraint and the still high level of the Australian dollar,” the RBA said in its quarterly monetary policy statement in Sydney today. At the past three meetings the board judged “it was appropriate to hold the cash rate steady, but not to close off the possibility of reducing it further, should that be needed to support economic activity,” it said.
The central bank projected gross domestic product will rise by between 2 percent and 3 percent in the year to December 2014, compared with 2.5 percent to 3.5 percent forecast three months earlier. The outlook for inflation is “to remain consistent” with the 2 percent to 3 percent target, the RBA said.
“The RBA has kept the door open to further easing,” said Katrina Ell, an economist at Moody’s Analytics in Sydney. “The high exchange rate, coupled with below-trend growth necessitates an easing bias remain. Luckily, inflation is within target to allow the possibility of further rate cuts.”
The central bank is balancing one of the Group of 10 currencies’ strongest performances and a weaker labor market against a recovery in home prices that’s beginning to spur dwelling investment. Contained inflation allowed Governor Glenn Stevens and his board to cut the cash rate by 2.25 percentage points in the past two years, aiming to underpin growth as a once-in-a-century mining-investment boom wanes.
The Aussie fell as low as 94.28 U.S. cents and traded at 94.62 U.S. cents as of 12:27 p.m. in Sydney. The currency has advanced about 6 percent since the end of August, the best performance after New Zealand’s kiwi dollar among major developed markets.
The RBA highlighted the potential risks from accelerating property prices.
“If housing market conditions strengthen more substantially, the associated boost to wealth and sentiment could result in lower saving and stronger-than-expected consumption growth,” it said. “If this were accompanied by a return to increasing household leverage, it could raise concerns from the perspective of financial stability, although to date growth of housing credit overall remains moderate.”
Traders priced in a 12 percent chance of a quarter-percentage point cut in the cash rate to 2.25 percent at the central bank’s December meeting and a 25 percent chance of at least one reduction for the March meeting, rate-swaps data compiled by Bloomberg showed.
The central bank said it has already delivered a “substantial degree” of policy stimulus and the effects still have further to run. It reiterated concerns about the local dollar, which has climbed after the Federal Reserve’s decision to postpone unwinding record stimulus.
“With the terms of trade forecast to decline only modestly over the coming years, there is some chance that the exchange rate will remain around current levels over the forecast horizon,” the central bank said, basing its forecasts in the statement on the Aussie at 95 U.S. cents. “However, lower capital inflows associated with the decline in mining investment could act to reduce the exchange rate, as could a reduction in stimulatory monetary settings in large economies.”
The RBA estimated in today’s statement that the share of mining investment in GDP will decline by about 3 percentage points over 2 1/2 years.
“Overall, non-mining investment is expected to remain subdued in the near term,” the RBA said. “Surveys of firms’ intentions suggest that there will be little growth in non-mining business investment over the next year or so.”
Treasury in August predicted the jobless rate would rise to an 11-year high of 6.25 percent by July next year. The RBA, which doesn’t forecast a jobless rate in the statement, said today unemployment “is likely to continue to drift higher for a year or so” then drop through 2015 as non-resource activity picks up.
Looser policy -- the cash rate stands at 2.5 percent -- is spurring employment-intensive residential building. A private index of construction in October showed growth for the first time since 2010; building permits jumped 14.4 percent in September and new-home sales climbed at the fastest pace since April 2012.
“The recovery in dwelling investment is expected to continue, and to accelerate somewhat, over the forecast period,” the central bank said. “The environment for this form of investment remains favorable, with low interest rates, rental yields that are around the highest they have been for a decade and support for first home buyers that favors construction of new dwellings.”
The RBA said China, Australia’s biggest trading partner, is expected to “grow a little faster in 2013 than previously anticipated,” though still close to the government’s target of 7.5 percent. It said domestic demand is likely to remain strong.
In Australia, business and consumer confidence have also revived since Tony Abbott’s coalition restored majority government on Sept. 7. Yet the budget deficits confronted by the federal and state government indicate fiscal tightening will weigh on growth.
“Growth of public demand is expected to be very low relative to its historical average,” the RBA said. “Consistent with budget projections, the contribution to GDP growth from public demand over the forecast period is expected to be around one-third of its historical rate.”