• The RBA’s concern about Australia’s housing market downturn spilling over into other parts of the economy appears to be growing.
• At its February meeting, it noted that: “if prices were to fall much further, consumption could be weaker than forecast, which would result in lower GDP growth, higher unemployment and lower inflation than forecast”.
• The bank still regards further progress in reducing unemployment and lifting inflation as a “reasonable expectation” with steady policy settings.
• Financial markets and an increasing number of economists disagree.

The Reserve Bank of Australia (RBA) has made it clear in recent commentary that the outlook for unemployment is crucial in terms of the next direction in Australia’s cash rate.

The movements in house prices could son be added to that list.

Here’s a passage from the minutes of the RBA’s February monetary policy meeting explaining why:

From a longer-run perspective, members assessed that, following such large increases in housing prices, the effect of the recent price falls on overall economic activity was expected to be relatively small. However, members observed that if prices were to fall much further, consumption could be weaker than forecast, which would result in lower GDP growth, higher unemployment and lower inflation than forecast.

Clearly, after largely overlooking the risks posed by the downturn in property prices, at least according to public statements, the RBA is now acknowledging falling home prices could lead to slower economic growth, higher unemployment and a big challenge in returning inflation to the midpoint of its 2-3% inflation target.

It acknowledged that “dwelling investment was also expected to decline more sharply than previously expected, consistent with the decline in residential building approvals and the fall in housing prices”.

It also noted that the slowdown in consumption seen in the September quarter, coupled with with subdued growth in retail sales in the final three months of 2018, may have been influenced by “lower housing prices and reduced housing market activity”.

As such, it admitted that “uncertainty about the recent momentum of consumption and factors affecting households’ future consumption decisions remained a key risk for the domestic economic outlook”.

However, while the RBA is clearly alert to these risks now, it still remains optimistic that the housing market won’t upend the broader economy, nor warrants lower official interest rates as yet.

“Given that further progress in reducing unemployment and lifting inflation was a reasonable expectation, members agreed that there was not a strong case for a near-term adjustment in monetary policy,” the key final paragraph of the minutes read.

“Rather… it would be appropriate to hold the cash rate steady and for the Bank to be a source of stability and confidence while further progress unfolds.”

Given the recent trajectory of some Australian economic data, financial markets are clearly not sure that stability is required, nor helping to build confidence, continuing to price in a full 25 basis point rate cut from the RBA by the middle of next year. A small but increasing group of market economists also share this view.

Upcoming economic data will go a long way to determining what will happen next with the cash rate.

Given the RBA’s nod in the February minutes, housing data looks set to play a prominent role.

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