Reserve Bank of Australia sees scope for easier policy

Australia's central bank maintained its forecast of accelerating growth in response to easy policy, even as risks around key trading partner China cast a shadow over the regional economic outlook. The Reserve Bank of Australia trimmed its inflation forecast for the year through June 2016 and its 2017 growth projections in a quarterly monetary policy statement Friday but it kept most of its estimates unchanged.

"A further increase in growth in household incomes and demand is anticipated, supported by rising employment, low interest rates and lower" gasoline prices, it said "The outlook for China's growth is a significant uncertainty for the outlook for the Australian economy."

Australia is benefiting from a depreciating local dollar that helps insulate the economy from shocks abroad and increases the competitiveness of local industries, whereas jurisdictions like Europe and Japan are struggling with their currencies. Policy makers kept rates unchanged at a record-low 2 percent Tuesday for a ninth month as they gauge the impact of recent financial market turbulence on global and domestic growth.

"If the RBA is going to be pushed off its 2 percent-perch it's going to be from offshore headwinds, not domestically," said Annette Beacher, head of Asia-Pacific research at TD Securities in Singapore, referring to what might drive a rate cut. "Domestically they seem very comfortable." Traders are pricing in a better-than80 percent chance the RBA will cut rates in the next six months. The Australian dollar was little changed from before the statement, trading at 71.93 U.S. cents at 12:45 p.m. in Sydney.

The market upheaval in part reflects "concerns about the evolving balance of risks in China and the ability of the Chinese authorities to manage a challenging economic transition," the central bank said today. "Any sharp slowing in economic activity or increase in financial stresses in China could spill over to other economies in the region."

China devalued its currency in August and then undertook an eight-day stretch of weaker yuan fixings through Jan. 7, roiling global financial markets and fueling concern it was favoring depreciation to revive the slowest growth in a quarter century. China's central bank has at the same time been burning through its currency reserves to support the yuan amid record capital outflows. At the same time, Australia recorded its biggest quarter of employment growth on record at the end of last year and unemployment fell to 5.8 percent, even as the economy was on course to expand at a below-trend pace.

"It is possible that the strength in the labor market data contains information about the economy not apparent in the national accounts data," the RBA said. "In part, employment growth appears to have reflected the relatively strong growth of output in the more labor-intensive sectors of the economy, such as household services."

The RBA is trying to orchestrate a transition away from mining investment to other industries in the economy, using low rates and a weaker dollar as a tailwind for industries. In some areas this is working: rising house prices have fueled a residential construction boom and conditions for business are above average. Yet there is still no sign of an uptick in investment outside the mining industry while resource firms are about half way through the unwinding of their spending programs.

Reflecting lower global commodity prices, the central bank today lowered its forecast for the terms of trade, or the ratio of export prices to import prices, by about 4 percent compared with its November estimate. Given inflation is low and the central bank expects little upturn, it reiterated that there may be "scope for easier policy, should that be appropriate to lend support to demand."

While global central banks are struggling with disinflation or outright deflation that an open economy like Australia's will be exposed to, one of the curiosities to date is the lack of pass through of higher import prices from a falling currency. The RBA said today that based on history, the direct effect of the depreciation since early 2013 should add about half a percentage point to underlying inflation over each year of the forecast period. It indicated this time may be a bit different. "Heightened competitive pressures, including from new entrants into the Australian retail market, and greater efforts by retailers to reduce their costs and improve efficiency, are continued to limit the extent to which higher import prices are evident in final retail prices for some time," the RBA said.

That's a boon for consumers. The central bank also said its forecast for better household consumption and income growth -- reflecting higher employment and the plunge in gasoline prices - - indicate the nation's savings ratio is likely to decline less than previously expected. The RBA said its liaison with retailers "suggests that trading conditions improved in the Christmas and post-Christmas sales period." Government data issued at the same time as the RBA's statement showed retail sales were flat in December.