Australian central bank slashes inflation forecasts

Australia's central bank slashed its inflation forecasts on Friday, sending the local dollar reeling as investors moved to fully price in another cut in interest rates this year. In its 66-page quarterly report, the Reserve Bank of Australia (RBA) now sees underlying inflation at just 1 to 2 percent for 2016, down from its previous prediction of 2 to 3 percent. It expected only a modest pick-up to 1.5 to 2.5 percent through to mid-2018.
The local dollar slid below 74 US cents to its lowest in two months. The central bank aims to keep inflation within a 2 to 3 percent band over the medium term. "The new forecast that underlying inflation will remain below the 2-3 percent target range until the middle of 2018 supports our long-held view that interest rates will be cut again to 1.5 percent before long," said Paul Dales, chief Australia & New Zealand economist at Capital Economics.
Dales expects another easing in August. On Tuesday, the RBA cut its cash rate by 25 basis points to an all time low of 1.75 percent, citing surprisingly low inflation readings for the first quarter. Interbank futures were quick to fully price in a cash rate of 1.5 percent by year-end.
LITTLE WAGE GROWTH The downward inflation revision reflected an expectation that domestic pressures, including labour costs, will pick up more gradually than previously anticipated. It cut forecasts for wage growth and warned it would "remain around current low levels for longer than previously forecast and pick up only very gradually."
This, it said, reflected workers from moving from highly paid mining jobs as the country transitions from a mining investment boom to services-led growth. "The outlook for domestic cost pressures is a key source of uncertainty," the RBA noted, adding another big unknown is how the exchange rate will react to a myriad of overseas risks.
"It may respond to a number of influences, including any unanticipated changes to the outlook for growth in China, commodity prices or the monetary policy decisions of the major central banks," the RBA said. "It therefore represents a significant source of uncertainty for the forecasts of inflation, as well as for the outlook for growth in activity." The central bank sees the economy growing at 2.5 to 3.5 percent in 2016, lifting slightly to 3 to 4 percent by mid-2018, thanks to low interest rates and a weaker local dollar.