Reserve Bank of Australia keeps the cash rate on hold in February

There have been some important developments in relation to the outlook for interest rates over recent months. The market now expects the Reserve Bank of Australia (RBA) to raise interest rates in the first half of 2018.

While the RBA left the cash rate at 1.5% at its February meeting, it noted that:

conditions in the global economy have improved over recent months…Above-trend growth is expected in a number of advanced economies, although uncertainties remain.

RBA Feb 2017

While Australian economic growth (GDP) for the September quarter was weak, the RBA suggested this reflected temporary factors and wasn’t a true reflection of the broader economy. Indeed, economic data released since then suggest the economy may be picking up.

For example, the NAB business conditions index has recently increased to its highest level since the Global Financial Crisis.  The RBA expects Australian growth to return to around 3% per annum by the end of the year.

Inflation in Australia remains quite low, however it is expected to pick up over the course of 2017 – see chart below. The blue line represents the RBA’s inflation forecast within a range.

Graph showing that inflation is trending upwards towards RBA's target. Sources: Datastream; RBA

The increase in commodity prices over recent months has boosted the earnings outlook for Australian resource companies and the A$. If these high prices are sustained, the benefits of higher commodity prices could spill over to non-mining sector company earnings in the year ahead.

In addition, the drag on domestic economic growth from lower mining investment is likely to diminish in 2017 and 2018.

Around this time last year, economists had been expecting interest rates in Australia would drop further. However, with global growth accelerating through last year, domestic business confidence strengthening and commodity prices higher, it is now looking as though the next move for interest rates is more likely to be an increase.