RBA: another snoozefest

BY DEB SHAW | 

  • With mixed data, weak inflation and high debt, RBA likely to stay on hold
  • Falling bond yields reduce the relative attractiveness of the Australian dollar
  • Our short-term and medium-term outlook on the currency remains bearish

This is a big week for economic data and events in Australia. The two most important releases to watch include the RBA’s interest rate decision tomorrow and GDP growth on Wednesday. Despite rate hike hopes throughout the year, the RBA has militantly pursued a neutral monetary policy. As such, consensus continues to expect no change to the current cash rate of 1.5%. We have the same expectation, and believe that the RBA is likely to remain on hold.

 

With mixed data, RBA in no hurry to upset the apple cart

While the Australian dollar has been in a bearish trend since late September, recent economic data has been fairly mixed. Last week NAB Business Conditions suggested that corporations remain optimistic, however wage growth, new jobs and the employment participation rate remain weak. Earlier in November, retail sales also missed estimates. While upcoming GDP figures may be helped by corporate spending, exports and the real estate sector, the Australian consumer is clearly under pressure.

The household debt-to-income ratio has been highlighted by the RBA as a risk in the recent past, making more rate hikes fairly unlikely. Given the poor financial wellbeing of most consumers, further rate hikes could push many indebted Australians over the edge. Even a modest hike could result in substantial financial hardship, given the scale of consumer debt in the economy. According to the Bank’s estimates, household debt-to-income is currently over 175%.

Looking at inflation, official figures from the Australian Bureau of Statistics continue to suggest that inflation is decelerating. Q3 inflation came in at 1.8%, lower than 1.9% in Q2 2017. While monthly (unofficial) inflation figures have accelerated recently, this has yet to factor into the RBA’s calculations. All in all, the RBA has almost no reason to hike tomorrow. A continuation of the status quo is therefore the most likely outcome.

 

With RBA in hibernation, bond yields fail to excite investors

Looking more closely at the Australian dollar, the currency is likely to remain weak as bond yields remain capped thanks to the RBA’s neutral policy. Relative to other currencies that have experienced rising yields (the US dollar in particular), Australian yields have been lethargic. This is shown visually below:

With higher USD rates, who wants the Aussie?

12-4-2017 AU US 2Y
Source: TradingView.com / MarketsNow
Note: 2-year US  government bond yields shown in blue

 

As can be seen above, short-term bond yields for US government bonds have recently strengthened beyond those offered for Australian government bonds. As the relative attractiveness of AUD bonds falls, investors have fewer reasons to hold on to the currency. While longer-term Australian bonds (such as 10-year government bonds) still offer a superior yield, this advantage is also fading in relative terms.

With the RBA on hold and the US Federal Reserve set to keep hiking, this picture is likely to worsen in 2018 and beyond. Our short-term and medium-term outlook on the Aussie remains bearish.