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Bill Evans, Research Analyst at Westpac, suggests that Australia’s headline inflation looks like falling below 2% for a fifth consecutive calendar year and it must be weighing on expectations.

Key Quotes

“Last week the Reserve Bank surprised by lowering its inflation forecasts for 2018 (both underlying and headline).”

“Headline was lowered from 2.25% to 1.75% and underlying was lowered from 2% to 1.75%.”

“If correct, that means underlying inflation will have printed below the bottom of the 2-3% target range for three calendar years in a row. Headline inflation will have printed below the bottom of the 2-3% target for five calendar years in a row.”

“This comfort that inflationary expectations appear to be settling around the inflation target is the key reason why the Bank resists the periodic calls to lower the target.”

“The Bank believes that the existence of the target is a dominant driver of inflationary expectations. Consequently, if the target were to be lowered, then expectations would fall and a more disinflationary environment would evolve. This puts considerable weight on the target as a driver of expectations.”

“Furthermore, they have made it quite clear that the next move in rates is up. Reasonably, economic agents could conclude that, even after five years, there is no urgency to reach the target.”

“To try to get it back to 2.5% very quickly, it would be mainly through people borrowing more money, and having higher asset prices “” I think that’s a much bigger risk to our economy than people having surprisingly low inflation expectations.”

“Reasonably, we can conclude that after five years of missing the bottom of the target zone, a more aggressive pursuit of the inflation target has been constrained by the need to address Australia’s challenges around financial stability.”

“The Bank is currently forecasting that despite three years of above trend growth (3.25% in 2018; 3.25% in 2019; and 3% in 2020 against a trend growth rate of 2.75%) inflation (headline and underlying) will only have lifted to 2.25% by 2020.”

“Perhaps that looks cautious but with inflationary expectations potentially anchored at or below 2%, it might be a tough target to achieve unless the Bank was willing to signal that it was prepared to pursue its target more aggressively.”