The latest economic summary from NAB, released today, suggests that the immediate impact of Bexit is more benign than was expected. But NAB says the RBA may need to cut the cash rate to 1%, and even try unconventional policies to try and lift growth in the local economy.
Whilst Australian economic growth is expected to remain resilient at 2.9% in 2016 and 2017, despite significant variation across industries and states, the risks to the outlook going into 2018 are becoming increasingly apparent, as LNG exports flatten off at a high level and the dwelling construction cycle turns down.
Against these headwinds, the economy may require additional policy action to support growth, especially if the RBA hopes to see inflation return to within its 2-3% target band. Both global and domestic disinflationary pressures are expected to keep CPI inflation below the target band for an extended period, while structural shifts in the economy and modest economic growth risk upward pressure on the unemployment rate.
The economy is then expected to lose some momentum in 2018, which together with the very low inflation outlook, will prompt the RBA to cut the cash rate in both May and August 2017 by 25bps each to a historic low of 1%. Even with this extra stimulus, growth is expected to slow to 2.6% in 2018, and the unemployment rate remain reasonably elevated at 5.6%. Price and wage pressures will remain subdued.
Our forecasts are also dependent on further depreciation in the AUD, although there are significant risks around our view that the AUD will track down to a low of USD69 cents by mid-2017, not least due to the reliance on either a Fed or a volatility-induced rise in the USD, which cannot be guaranteed. A lower iron ore price (as per our forecasts) would also assist the currency.
The composition of the new Australian parliament suggests that achieving consensus on microeconomic and tax reform will be challenging, while the threat of a rating downgrade by S&P will see continued emphasis on fiscal consolidation. This will continue to place pressure on monetary policy and any further deterioration in the growth outlook following the cuts in May and August 2017 is likely to prompt consideration of non-conventional monetary policy tools such as asset purchases.
We now expect the RBA will need to provide further support through two more 25bp cuts in May and August 2017 (to a new low of 1%), which should be enough to stabilise the unemployment rate at just over 5½% and prevent economic growth from dropping below our forecast of 2.6% in 2018.
Monetary policy deliberations may then turn to the possible use of non-conventional policy measures if the outlook deteriorates further.
Additionally, persistent weakness in CPI inflation could potentially trigger a rate cut even sooner than expected.
