Australian business conditions and confidence both weakened in July and looking out to 2018, the National Australia Bank believes the Reserve Bank will have to cut rates twice to soften the blow from growing long term risks and persistently weak inflation. The forecast represents a major change of heart by the bank which has not seen the need for more rate cuts from the RBA.
In commentary accompanying its latest business survey yesterday, the NAB’s chief economist Alan Oster said longer-term risks are growing, with the housing boom likely to fade and mining investment and exports likely to remain weak. And the central bank could be forced to cut rates twice to help sustain the economy and bring inflation back to its target range of 2% to 3% over time.
"To stabilise the unemployment rate (at around 5½%) we expect the RBA will feel the need to provide further medium term support through two more 25bp cuts in May and August 2017 (to a new low of 1%). And thereafter raises the prospect of the RBA thinking about the use of non-conventional monetary policy measures,” the bank said.
“NAB continues to see a reasonably solid economy in the near-term, supported by an improved non-mining economy (particularly with strong growth in residential construction) and increased hard commodity production.
“This is evidenced by the NAB Business Survey, which has consistently shown very high levels of business conditions and positive confidence, despite some large external shocks (such as the Brexit vote).
“However, 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.
“Consequently, NAB’s forecasts for GDP growth are factoring in more headwinds going forward, widening the spread between NAB and RBA forecasts to around 1½ ppts by late 2018 (NAB forecast 2.2% over 2018 vs RBA’s 3-4%),” the bank said yesterday.
“These headwinds may require additional policy action to support growth, especially if the RBA hopes to see inflation return to within its target band,” Mr Oster said yesterday.
"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 will leave the unemployment rate under pressure.
“With inflation forecasts still very low and the RBA showing its hand as a committed ‘inflation targeter’, it is seemingly less worried than we thought about using up some of its valuable remaining monetary policy ammunition, the case for further cuts from the RBA appears to be mounting," Mr Oster wrote yesterday.
The RBA cut interest rates last week to a record low 1.50% from 1.75%. The central bank said Friday in its latest Statement on Monetary Policy that it expects inflation to remain below its 2% to 3% inflation target band for most of the period to the end of 2018.
The commentary yesterday is a change of stance for NAB, which had previously seen no need for further interest-rate cuts, saying business was fundamentally sound and a transition in the economy from mining to services was well advanced.
NAB’s business conditions index, a net balance of respondents to its survey, fell to +8 in July from +11 in June. The business confidence index fell to +4 in July from +5 in June.
Mr. Oster said near-term trends in the economy remain reassuring.
"Although some of the headline measures from the survey eased a little in the month, we continue to be encouraged by the results," he said.
"The outcome is still suggesting that the near-term outlook for the non-mining economy is a good one, which is helping prop up demand for labor, albeit primarily in the major eastern states," he added.
