Australia Holds Rates as Lowe Says Unemployment Key to Outlook

(Bloomberg) -- Australian central bank chief Philip Lowe kept his head below the parapet by keeping interest rates unchanged less than two weeks out from an election, saying lower unemployment is needed to drive faster inflation.

Lowe left the cash rate at 1.5 percent -- where it has stood since he took the helm in September 2016 -- after economists and money markets were almost evenly divided on the decision. This was the governor’s first meeting where an adjustment was in play, with a swathe of economists switching to calling cuts following weak first-quarter inflation.

The board “recognized that there was still spare capacity in the economy and that a further improvement in the labor market was likely to be needed for inflation to be consistent with the target,” Lowe said in his statement. “Given this assessment, the board will be paying close attention to developments in the labor market at its upcoming meetings.”

The Reserve Bank resisted intensifying pressure to ease as it sought to avoid entering the pointy end of an election campaign. Lowe is holding fast to his view that solid hiring will tighten the labor market sufficiently to spur wages growth. That’s despite a slowing economy and weaker consumer-price growth.

The Australian dollar rose after his announcement, buying 70.41 U.S. cents at 3:18 p.m. in Sydney, compared with 70.01 cents before the statement. Three-year bonds tumbled, sending yields up 7 basis points to 1.31 percent, the steepest increase since April 2018.

Rates traders pushed back expectations for a cut, fully pricing in the first one in September, after yesterday being certain a reduction was coming in July.

“The main domestic uncertainty continues to be the outlook for household consumption, which is being affected by a protracted period of low income growth and declining housing prices,” Lowe said. “Some pick-up in growth in household disposable income is expected and this should support consumption.”

The arguments for a rate cut have become more compelling as the year has progressed: a sharp slowdown in economic growth, tepid inflation, falling property prices, weak household spending, high debt and stagnant wages.

The key reasons for holding remain solid hiring and unemployment close to an eight-year low, reasonable investment and an upbeat trade picture as commodity exports remain strong. In addition, both major parties are promising tax cuts, cash rebates and infrastructure investment that should support the economy.

Lowe said the central scenario is for the Australian economy to grow by around 2.75 percent in 2019 and 2020. That’s down from the previous 3 percent pace forecast for this year.

The RBA’s confidence in its outlook has wavered amid weakening consumer spending that tied in with tumbling house prices, which are down 14.5 percent in Sydney from their 2017 peak. The board abandoned a tightening bias in February.

“The inflation data for the March quarter were noticeably lower than expected and suggest subdued inflationary pressures across much of the economy,” the governor said. “Looking forward, inflation is expected to pick up, but to do so only gradually.”

Contradictions

Lowe has reiterated that the labor market remains central to the outlook and has pointed to positive forward indicators of employment. Yet there have been signs of that turning, and a private report earlier today showed construction jobs fell in April at the steepest rate in six years.

Like other developed nations, the RBA has been confounded by the contradictions showing up in the economy: growth slowed in the second half of 2018 to an annualized 1 percent from almost 4 percent in the first six months; at the same time, unemployment dropped and government coffers were awash with tax revenue from strong job gains.

“The Australian labor market remains strong,” Lowe said today. “There has been a significant increase in employment, the vacancy rate remains high and there are reports of skills shortages in some areas.”

©2019 Bloomberg L.P.