OECD tells RBA to take a hike

"The economy will continue growing at a robust pace. Business investment outside the housing and mining sectors will pick up, with exports boosted as new resource-sector capacity comes on stream. The strengthening labour market and household incomes will sustain private consumption, and inflation and wages will pick up gradually."

This is how the OECD sees Australia's future (at least over the next two years) as written in its 'Australia - Economic forecast summary (November 2017)' report.

The OECD's predictions include: GDP growth of 2.5% in 2017, 2.8% in 2018 and 2.7% in 2019; core inflation at 1.7% in 2017, 2.1% in 2018 and 2.2% in 2019; unemployment rate at 5.6% in 2017, 5.4% in 2018 and 5.3% in 2019.

This compares with the RBA's forecasts written in its November 2017 'Statement on Monetary Policy'. It's better on GDP growth - 2.5% in 2017, 3.25% in 2018 and 3.25% in 2019. Not so in terms of inflation moving up to target - core inflation at 1.75% in 2017, 1.75% in 2018 and 2% in 2019 - and more or less in line with regards to the unemployment rate - 5.5% in 2017, 5.5% in 2018 and 5.25% in 2019.

Case for a rate hike? The headlines think so: "Reserve Bank to hike cash rate, OECD says" (The Sydney Morning Herald); "OECD says Australian economy ready for higher RBA rates" (The Australian Financial Review); "RBA to start raising cash rate in latter half of 2018, OECD tips" (The Australian).

And rightfully so for there was no mistaking the words written in the OECD report.

"Monetary policy remains supportive; the policy rate has been kept at 1.5% since August 2016. Policy tightening is projected to begin in the second half of 2018 when the pick-up in wages and prices becomes more entrenched".

Fair enough (based on the OECD's projections and rationales). But unlike the bible quote, "So let it be written. So let it be done", oftentimes what was written is not what's done...especially in the world of forecasting.

For sure, the OECD has rational justifications - optimistic growth, unemployment, wages and inflation forecasts - and intentions for its rate hike prescription.

"A tighter policy stance will ease pressures on house prices and will reduce the threat of the build-up of other financial distortions. Indeed, housing markets in certain areas already show signs of easing."

That's all well and good...but whether it ends well is a different matter altogether.

Remember that an economy doesn't operate in vacuum and unlike the Newton's third law of physics, an action (by the RBA) might not trigger an equal opposite reaction.

A gentle 25 basis point hike could trigger an outsized fall in the housing market (probably on expectations for more). This would affect lenders and ancillary sectors servicing the industry - bricklayers, painters, household furnishings, conveyancers, etc. - sending profits down and affecting the stock market. The wealth effect of rising home values and stock market prices turns down and weakens already weak consumer spending that's weakened by sluggish income growth. A testament to the property sector's large multiplier effect on the economy.

A gentle 25 basis point hike could strengthen the Australian dollar - eroding the "strong commodity prices and exports underpin growth" the OECD talks about. Not to mention, the stronger Australian dollar's downward pull on inflationary pressures.

Continued low inflation means continued sluggish wage growth (by virtue of CPI indexation) and further reduction in household spending.

It's still about seven months until the "advised" rate hike. Anything can still happen, the OECD and the RBA's forecasts could prove on point.

If so, hike away RBA.

Read more: OECDAustraliaGDPMonetary PolicyCPINewtonReserve BankSydney Morning Herald
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