The Reserve Bank of Australia (RBA) has defied expectations of some leading economists who were predicting an interest rate cut before the federal election.
The RBA has instead opted to hold the cash rate steady at 1.5%, which caused the Australian dollar to jump comfortably above US70 cents in the minutes after the central bank released its decision.
The S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index also lost ground and gave up some of the day's gains to trade 0.2% higher after the RBA's decision compared to a circa 0.4% gain earlier.
There clearly was some expectation of a rate cut baked into markets but I don't think the RBA's decision today will change the odds of a rate cut later this year.
Why the RBA is more optimistic than anticipated
Our central bankers have clearly opted for the "glass half full" view of the world to justify holding the official cash rate steady. The statement by RBA governor Philip Lowe today said the outlook for the global economy was reasonable, although it did acknowledge that the risks were to the downside.
I can't help but feel Dr Lowe was referring to the tweets by US President Donald Trump yesterday that could trigger a full-blown trade war between China and the US.
But that wasn't enough to worry the RBA, not when global financial conditions were "accommodative" in Dr Lowe's view.
"Long-term bond yields are low, consistent with the subdued outlook for inflation, and equity markets have strengthened. Risk premiums also remain low," said Dr Lowe.
"In Australia, long-term bond yields are at historically low levels and short-term bank funding costs have declined further. Some lending rates have declined recently, although the average mortgage rate paid is unchanged. The Australian dollar is at the low end of its narrow range of recent times."
No cut to growth forecast
These factors were enough to stave off a rate cut and justified the RBA sticking to its GDP growth forecast of 2.75% in 2019 and 2020.
It also predicted that stubbornly low inflation will start to pick up and that the employment market will remain robust.
This stands in contrast to the outlook from more dovish economists, especially after the latest inflation data that showed an unexpected zero increase in prices. The inflation reading was the trigger that convinced some that interest rates were coming down today.
The RBA's growth forecast of 2.75% also looks somewhat too bullish. The thinking was that the RBA would lower the growth target and that would justify a rate cut today.
The new top priority of the RBA
That hasn't happened but there was something else new and interesting in Dr Lowe's statement. He said that the board was "paying close attention to developments in the labour market at its upcoming meetings".
What this signal to me is that the RBA won't be putting as much weight on inflation readings in the near-term as it will on jobs.
The RBA board is more worried about weakness in the job market than it is about inflation, even though inflation targeting is seen as a key mandate for central banks.
