RBA on hold, but expect hikes in 2018: Paul Bloxham

Most of the timely indicators of domestic economic activity suggest that growth is set to pick up pace in coming quarters (we expect year-ended GDP growth of 3.3% over 2017).

Key amongst these indicators are surveyed business conditions, which are around decade highs, and employment growth, which has picked up recently with sufficient momentum to push the unemployment rate lower.

A major driver of these developments has been an improvement in conditions in the mining sector, which has spent a number of years in retreat. Higher commodity prices and the end of the decline in mining investment mean that the resources sector is a tailwind, rather than a headwind for growth (see A commodity prices tailwind, finally, 17 January 2017). The latest manifestation of this has been the strong profits reported by Australia’s miners. The timely economic indicators have also been supported by a bounce-back in activity after poor weather held back Q1 GDP. Retail sales, non-mining investment and coal exports have risen recently. Reflecting this, we revise up our Q2 GDP growth forecast to 0.9% q-o-q (previously 0.5%).

A key question for the RBA remains whether the expected lift in growth will feed through to a pick-up in wages growth and domestic inflation. Weak wages growth has been a factor that has weighed on consumer sentiment and growth in household consumption. We expect wages growth to pick up modestly in the second half of 2017, due to a boost to the minimum wage and the impact that the lift in corporate profitability typically has on wages growth. This should mean that domestic inflation is past its trough, and we see the underlying inflation measures lifting back into the bottom part of the 2-3% target band in coming quarters.

Above trend growth, a modest lift in wages growth and underlying inflation, plus still uncomfortably exuberant Sydney and Melbourne housing markets are, in our view, likely to be sufficient to see the RBA lifting its cash rate in early 2018.

On fixed income strategy, we see potential for more money market risk premium but there is little to fear for the long-end even if the RBA tightens policy next year.