Today's release of the Reserve Bank of Australia's (RBA) board meeting minutes suggests that the central bank could still be forced to cut interest rates to stimulate growth next year.
While the RBA says that a period of low-interest rates had stimulated the housing market, it did note that underlying inflation (CPI) was expected to be close to 2% over the course of most of next year, before picking up to 2.5% in the second-half of the forecast period (ending June 2017).
Gross Domestic Product (GDP) growth is expected to be between 2% and 3% to around June 2016, before rising to between 2.75% and 3.75% over the year to June 2017.
That seems to suggest that if conditions remain the same, the official cash rate of 2% is unlikely to change much before the end of 2016. But the problem is that inflation has been trending lower, and one of the RBA's key tasks is to try and keep the inflation rate in a band between 2% and 3%. If CPI falls below 2%, the odds of a rate cut will rise dramatically.
The RBA is forecasting an underlying inflation rate of between 1.5% and 2.5% to June 2016, but recent trends suggest CPI is falling steadily, meaning inflation could be at the bottom end of the central bank's forecasts.
While the market is not expecting the RBA to cut the official cash rate when it meets in early December, we could see one or more rate cuts early next year, particularly if inflation continues to slide.
Two of the key factors the RBA watches are the Australian dollar exchange rate, and price moves in the housing market. The Aussie dollar is stubbornly clinging above US 70 cents, but is likely to fall once the US central bank begins to raise its interest rates. Housing price growth and auction clearance rates in Sydney and Melbourne have declined over recent months.
Both factors could allow the RBA to cut interest rates if it needs to – and it might need to for a couple of reasons apart from inflation falling below its target band.
Mining investment is still declining and not expected to bottom until the end of 2017. That means more pain for resources stocks and mining services companies, but weaker growth in global demand for commodities could see prices fall even further. Clearly, we are not yet at the bottom of the commodities cycle – bad news for miners like BHP Billiton Limited (ASX: BHP) and its recent spinoff South32 Ltd (ASX: S32). Commodity export countries Brazil and Canada have already fallen into recession, and Australia could follow.
China continues to ease monetary policy to increase growth, but we may still see China's economic growth slow, which will impact Australian economic growth.
Foolish takeaway
The RBA says economic conditions have improved and the forecast for the Australian economy was for growth to strengthen gradually over the next two years. But the biggest risk is still a slowdown in global growth, particularly in Asia, where Japan's economic recovery has hit a brick wall, and softening growth was being observed in the rest of east Asia.
While many economists are predicting the next move in the official cash rate to be up, we are a long way from there yet, and the next move is more than likely to be down.
