Reserve Bank backs Budget Economic Forecasts but warns US inflation a Growing Risk

Headshot of RBA deputy governor Guy Debelle

The Reserve Bank is confident Australia will meet, and possibly exceed, the economic forecasts in the Federal Government’s latest budget, but warns there are overseas risks to the outlook.

The bank’s deputy governor, Guy Debelle, said the RBA was becoming increasingly confident about Australia’s domestic economic recovery.

“It is worth noting that domestic demand growth has outstripped growth in GDP, running at around 3.25 per cent,” he told a business audience in Sydney.

“This gives us confidence in our forecast of GDP growth a little above trend over the next couple of years. That is, that GDP growth is likely to have a 3 in front of it.

“The surveys of business conditions very much support that assessment, with conditions in many parts of the economy assessed to be well above average.”

In its 2018-19 budget, released last week, the Government forecast 3 per cent economic growth for the next four years, a number some private sector economists view as overly optimistic.

However, while the RBA expected smooth sailing domestically, it warned about the prospect of economic and financial disturbances from overseas.

“The US fiscal stimulus is still to have its full effect in an economy that … is very close to full capacity,” Dr Debelle said.

“This is a similar situation to that in the late 1960s and could lead to more inflation in the US than currently anticipated.

“In turn, that could lead to more tightening in monetary policy than currently expected. While markets expect some tightening, they don’t expect too much more at this point.”

Such events in the US would likely see the Australian dollar fall, which would raise inflation in Australia along with domestic economic growth.

But Dr Debelle said there would probably be a lag before the effects were felt here, because Australia’s economy currently has spare capacity.

‘Next global downturn a matter of when, not if’

In a research note released before Dr Debelle’s speech, Deutsche Bank chief economist Adam Boyton pointed to a similar risk, although he appeared less sanguine about the potential fallout.

“After almost a decade, the expansion in the United States is very mature,” he observed.

“That means it’s time for Australia to start thinking more about how we might deal with the next global slowdown.

“So the next global downturn is more likely to be a matter of when, not if.

“If it comes in, say, mid-2020, then Australia would be entering the next global recession with the budget barely in surplus, net debt around 17 per cent of GDP and the cash rate likely to be around 2.25 per cent.

“Compare that to a budget surplus of 1.8 per cent of GDP, zero net debt and interest rates at 7.25 per cent when the GFC hit.

“The lack of policy ammunition is obvious. How to fix it isn’t.”

A key danger of faster rising US interest rates and a falling Australian dollar is that the Reserve Bank will be forced to lift interest rates domestically from their record low level of 1.5 per cent.

However, Dr Debelle was also relatively relaxed about that prospect.

“In thinking about the resiliency of household balance sheets to higher interest rates, it is important to think about the environment in which interest rates would be rising,” he said.

“That environment is highly likely to be one where wages and household incomes are also growing faster than currently, improving the ability of households to afford higher mortgage repayments.”

Tighter loan standards have ‘implications for house prices’

The other threat many economists have warned about to heavily indebted Australian households is a tightening of lending standards by banks in the context of the banking royal commission and regulatory crackdowns.

These economists are generally concerned reduced lending will slow currently solid consumer spending growth, thus weakening the economy.

However, Dr Debelle appeared nonplussed.

“There is a risk of a further tightening in lending standards in the period ahead,” he observed.

“This may have its largest effect on the amount of funds an individual household can borrow, more than the effect on the number of households that are eligible for a loan.

“This, in turn, means that credit growth may be slower than otherwise for a time. To me, that has more of an implication for house prices, than it does for the outlook for consumption.”