Chief economist update: The A$ will answer the question of how much more

When the Reserve Bank of Australia (RBA) met and decided to keep the official cash rate unchanged at 0.75% on November 5, Governor Philip Lowe issued this optimistic statement: "After a soft patch in the second half of last year, a gentle turning point appears to have been reached. The central scenario is for the Australian economy to grow by around 21/4 per cent this year and then for growth gradually to pick up to around 3%t in 2021."

"The central scenario remains for inflation to pick up, but to do so only gradually. In both headline and underlying terms, inflation is expected to be close to 2% in 2020 and 2021."

Concluding with the assurance that: "The board will continue to monitor developments, including in the labour market, and is prepared to ease monetary policy further if needed to support sustainable growth in the economy, full employment and the achievement of the inflation target over time."

The RBA's recently-released "Statement on Monetary Policy, November 2019" (SoMP) provides greater details:

The forecast variables appear to be rational and justify the governor's optimism, inferring that the RBA would just be sitting - on 0.75% cash rate - and waiting - for the lagged effects of this lowered interest rate to flow through into economic activity.

Then again, look at the fine print, footnote (a) - the technical assumptions "include the cash rate moving in line with market pricing". Markets are currently pricing another rate cut by February 2020 or as early as December this year.

Maybe not that soon but the SoMP confesses to at least another rate reduction next year.

"The domestic forecasts are conditioned on the technical assumption that the cash rate moves in line with market pricing, which implies some chance of a 25 basis point cut to the cash rate by the middle of 2020," it reads.

However, it seems that one more rate cut wouldn't do much for the Australian dollar - look at the fine print once more. The RBA assumes the A$ TWI at 60 and US$0.69. This means that the RBA expects the A$ to remain basically unchanged from November 6 when the technical assumptions were set.

Not to mention the upside risk for the domestic currency if or when its peers implement greater policy accommodation.

The RBA, itself, modelled the impact of the A$ appreciation/depreciation on the general economy...

... and explains that: "A sustained 5% appreciation of the exchange rate would be expected to lower GDP growth by 1/2 percentage point on average relative to the central forecasts, keep the unemployment rate at around 51/4 per cent (instead of declining to 5 per cent by the end of 2021) and keep trimmed mean inflation well below the bottom of the target band throughout the forecast period."

" The main channel through which the appreciation of the exchange rate affects the economy is, once again, the trade channel. Following the increase in the value of the Australian dollar, the price of Australian goods and services becomes less competitive. As a result, export volumes fall and imports increase.

"This is consistent with a higher purchasing power of domestic residents and lower import prices; for a given level of production, they can now afford to consume more imports."

The RBA will cut one more time in 2020. More, if other central banks, particularly the Fed, raise accommodative monetary policies ... if only to keep the A$ weak.

Read more: RBAPhilip LoweReserve Bank of Australia
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