Finely balanced but RBA remains on hold in May

The Reserve Bank of Australia (RBA) Board kept its benchmark cash rate on hold today at 1.50% for the 30th consecutive meeting. Today's meeting was very finely balanced; financial markets assessed the probability of a rate cut as close to 50/50, while 14 out of 26 economists surveyed by Bloomberg Australia were forecasting a rate cut. In the end, it was the Board's upbeat assessment of the labour market that prevented a move today.

As outlined in our preview, there were two key developments from the Board's previous meeting that set the scene for today's decision. Firstly, the Board signaled a shift to a data dependent approach for policy considerations. Secondly, April's meeting minutes outlined the specific scenario in which the Board would be prepared to cut; that being "where inflation did not move any higher and unemployment trended up".

Since April's meeting, we received updates on both the labour market (for March) and inflation (for Q1). The Governor in his Statement today described conditions in the labour market as remaining "strong", though it was noted that over the past 6 months, the unemployment rate had made "little further progress". On inflation, the assessment was that Q1's data was "noticeably lower than expected and suggest subdued inflationary pressures across much of the economy". It is clear that while inflation has decelerated, labour market conditions do not yet meet the threshold for the Board to cut.

As such, the last two lines of the Governor's statement focused specifically on the labour market by noting that the Board "... recognised that there was still spare capacity in the economy and that a further improvement in the labour market was likely to be needed for inflation to be consistent with the target. Given this assessment, the Board will be paying close attention to developments in the labour market at its upcoming meetings". Today's statement informed us that the Bank anticipates that the unemployment rate will remain around its existing level of 5.0% "over the next year or so, before declining a little to 4¾ per cent in 2021". At this stage, the indication appears to be that unless the unemployment rate moves lower from here, the Board will look to cut.

The next key development comes on Friday (10/5) when the Bank is due to release its quarterly Statement on Monetary Policy, including its updated forecasts for growth and inflation. The Governor outlined today that GDP growth was expected to increase by around trend (2.75%) this year and next, which on that basis would imply a 0.25% downgrade for 2019. Regarding inflation, the guidance was that the underlying (or trimmed mean) measure was forecast for 1.75% this year and 2.0% in 2020, implying a downward revision of 0.25% for both years. In that situation where underlying inflation is forecast to be below target in 2019, it is likely that the Bank will shift to a formal easing bias, with the unemployment rate being the key indicator to watch.