RBA likely to stay on hold for time being on moderate inflation outlook

Structural changes in Australia away from the mining sector and towards other sectors are progressing, noted Commerzbank in a research report. Expansionary monetary policy and a subdued currency since mid-2014 have underpinned the Australian economy, boosting domestic consumption and industries outside the mining sector. The decent growth seen in 2016 continued in the first half of this year.

The Australian economy expanded robustly by 1 percent in sequential terms in the first quarter and slowed down to 0.6 percent in the second quarter. But the third quarter economic growth was quite disappointing as Australia’s economy contracted 0.5 percent sequentially. The labor market has improved since mid-2015.

The jobless rate declined to 5.6 percent in October from 6.3 percent in early 2015. However, inflation pressure is low by historic comparison. The inflation measure preferred by the Reserve Bank of Australia has stayed below the central bank’s target range of 2 percent to 3 percent at 1.7 percent year-on-year in the first half of 2016.

Weak wage growth, along with globally low inflation would continue to hurt Australia’s inflation for the time being, stated RBA. Because of the subdued economic growth in the September quarter and the moderate inflation outlook, the Reserve Bank of Australia would remain on hold for the time being and stick to its expansionary monetary policy, according to Commerzbank. Furthermore, it would keep a close watch on the development on the labor market.

Given the continued subdued inflation pressure, additional rate cuts are not yet off the agenda. After all, the strong Australian dollar continues to be an issue for the Reserve Bank of Australia. The RBA has reiterated that a robust currency might “complicate” the process of necessary economic adjustments. A weaker dollar might assist in compensating for the negative effects of declining commodity prices that had put significant pressure on the Australian terms of trade. Furthermore, it exerts upward pressure on inflation by stimulating import prices, stated Commerzbank.

But commodity prices have rebounded slightly in recent times and rebounded the Australian terms of trade. But, the RBA expects that iron ore and coal prices in particular, which are vital for Australia, would continue to suffer from subdued demand because of the reduction of overcapacities in China for some time.

China’s economic weakness continues to be one of the most significant risk factors. If the situation in China worsens, the Australian central bank might cut the key rate again. But since domestic indicators have rebounded recently, the Reserve Bank of Australia is expected to refrain from additional rate reductions unless the economic situation deteriorates again unexpectedly, added Commerzbank.

At 10:00 GMT the FxWirePro's Hourly Strength Index of Australian Dollar was highly bearish at -106.186, while the FxWirePro's Hourly Strength Index of US Dollar was neutral at 28.7415. For more details on FxWirePro's Currency Strength Index, visit http://www.fxwirepro.com/currencyindex