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Australia central bank slashes inflation forecasts, lowers outlook for wages

A man and a women walk into the Reserve Bank of Australia headquarters in Sydney, Australia.
Mark Metcalfe | Getty Images

Australia's central bank slashed its inflation forecasts on Friday and warned that the outlook for wages and price pressures were a key uncertainty, suggesting the door was open to another cut in interest rates.

In its 66-page quarterly report, the Reserve Bank of Australia (RBA) gave no explicit guidance that it will ease again as it maintained its growth projections for a gradual strengthening through mid-2018.

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.

"The Board will continue to assess the outlook and adjust policy as needed to foster sustainable growth in demand and inflation outcomes consistent with the inflation target over time."

The RBA now sees underlying inflation at just 1 to 2 percent for 2016, down from a previous forecast of 2 to 3 percent. The central bank aims to keep inflation withing a 2 to 3 percent band over the medium term.

What's the impact of the RBA's interest rate cut?

It expected only a modest pick up to 1.5 to 2.5 percent through to mid-2018.

The downward revision reflected an expectation that domestic pressures, including labor costs, will pick up more gradually than previously anticipated, the central bank explained.

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, was consistent with the movement of workers from highly paid mining-related jobs to other employment.

"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."

For now, the central bank is maintaining its forecasts for gross domestic product growth. It sees the economy growing at a 2.5 to 3.5 percent pace for 2016, lifting slightly to 3 to 4 percent by mid-2018, thanks to low interest rates and a weaker local dollar.

The exchange rate fell sharply from 2013 to late 2015. It reacted negatively to Tuesday's rate cut decision, but held above the troughs reached in September.

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