By David Bassanese

The Reserve Bank decision to leave interest rates on hold this week, and its accompanying statements, seems to have led to confusion among some analysts. As one media commentator suggested, the outlook for interest rates was “as clear as mud”.

That maybe so, but it misses the far more important news arising from the RBA's latest analysis of the economy – which is undoubtedly good news, to the extent it can last. 

For starters, the RBA acknowledged that banks had unilaterally raised their mortgage rates in response to higher capital costs imposed on them by the Australian Prudential Regulation Authority (APRA).  

But far from warranting an immediate offsetting interest rate cut from the RBA – as one third of surveyed economists suggested would happen - the RBA merely argued the bank's actions would have only a “slight” dampening effect on borrowing and spending given that overall monetary conditions remained “quite accommodative”.

As the RBA noted, moreover, only “some” lending rates increased – namely variable rate housing loans - and not fixed rate home loan or business rates.

Further supporting the case for a rate cut, the RBA acknowledged that inflation appeared to be tracking “lower than earlier expected”.  This is not surprising given the still only muted growth in wages and the quite benign September quarter consumer price index result released last week. Notably, underlying inflation measures only rose 0.3% in the quarter and 2.25% over the year.  

Given this CPI outcome, it’s quite likely the RBA will revise down its near-term inflation forecast in this Friday’s quarterly Statement on Monetary Policy – as it would require an unlikely large rise in underlying inflation of 0.8% in the December quarter for the RBA's current 2.5% annual underlying inflation forecast for the quarter to be realised.  

The RBA will likely shave back its year-to-December forecast to 2.25%, though it might reasonably retain its current forecast that underlying annual inflation over the next year or so would lift to between to 2 to 3%.

The upshot of the lower than expected near-term inflation forecast is that, according to the RBA’s Statement yesterday, it “may afford scope for further easing of policy, should that be appropriate to lend support to demand”.  

Some took that as a reinstatement of the Bank’s easing bias, and then wondered why it did not simply cut interest rates. Others wondered why the RBA would reinstate such a bias when its broader comments on the economy were more upbeat.

Indeed, also notable yesterday was that the RBA beefed up its comments on the Australian economy noting that “business surveys suggest a gradual improvement in conditions over the past year”. Elsewhere, the RBA noted “the prospects for an improvement in economic conditions had firmed a little over recent months.” Exactly why it thought this is hard to tell – as the housing sector seems to be reaching a peak and prospects for drought have intensified.  Perhaps the RBA is being buoyed by the anecdotally evident new sense of optimism around the country since Malcolm Turnbull became Prime Minister.  

Either way, as seen in the chart below, some improvement in the economic outlook is evident from the lift in the National Australian Bank index of business conditions index though this year - to be at now consistently above-average levels.  While mining and manufacturing conditions remain weak, NAB report that the service sectors of the economy are improving.  

So far at least, however, measures of “confidence” among both business and households remain more patchy, though still only a little below long-run average levels.  

So we have the following situation: on the one hand inflation is lower than expected but, on the other hand, economic growth is also a bit better than expected. No wonder some seem to suggest the outlook for interest rates is unclear. 

But step back a little and this situation should be pleasing rather than confusing: low inflation means the RBA has even more latitude to cut interest rates if need be to support the economy (the hurdle has been lowered), but more upbeat indicators on the economy suggest there’s less reason to use this latitude anytime soon.  

While the overall net effect on the outlook for interest rates is fairly neutral – the implications for economy growth are unambiguously positive. The economy (at least in the RBA’s view) seems to be doing well enough not to need a rate cut, but the RBA is even more inclined to step in to support growth if need be.

The RBA’s confidence is such that it seems unlikely it will cut interest rates as early as December – unless something dramatic happens – and even a rate cut by February seems not much more than an even-money bet. For the RBA to cut rates, we’ll need to seen a significant deterioration in business conditions again and/or a renewed leap higher in the unemployment rate. 

I’m still expecting negative news to re-appear by mid-2016. But I have to admit corporate Australia is currently reporting improved business conditions and the labour market has remained remarkably resilient in the face of soft economic growth so far. 

For the economy’s sake, here’s hoping I’m wrong.