The Reserve Bank of Australia (RBA) concluded its meeting today and – as expected – left interest rates unchanged at 1.5%. As a result, the Australian dollar was little moved against the dollar, though it has seen a major increase in the past few days. On Wednesday, the pair started an upward surge, rising from 0.7472 to reach to a multi-weekly high of 0.7665 yesterday.

(Click on image to enlarge)

According to the accompanying statement, the officials said that the terms of trade were expected to decline over the next few years. They will nonetheless remain at elevated levels. This will mostly be caused by the increasing oil prices and the slow increase in the price of base metals.

As the officials have mentioned in the past few meetings, they are still concerned with the falling house prices in Sydney and Melbourne. The falling prices are attributed to the low wage growth and the oversupply of houses in the cities.

The officials were also concerned with the low wage growth, which has led to increased personal debt. These personal debt – coupled with the slow growth in the inflation rate – will likely call for more patience before the RBA raises interest rates. The low inflation rate has been caused by the low growth in labor costs and a strong competition in the retail sector. Yesterday, the retail sales data showed improved growth in May. The officials forecasted that the CPI inflation will be above 2% in 2018. This is also the target for the RBA. In the data released in April, the CPI was at 1.9%, which was lower than the expected 2.0%.

The officials expressed optimism and caution especially dealing with trade. They pointed that the country’s closest allies were doing well but were still threatened by the trade issue. As you recall, the US has moved to impose tariffs on the closest American allies. While Australia has been exempted from the steel and aluminum tariffs, the implications of slow growth rate and a trade war could pose a challenge to the Australian economy. For example, when the US exited the Iran deal, the price of crude oil moved up.

In the past few years, Australian economy has been diversifying from the mining sector which was the leading source of income for decades. The main commodities mined in the country are iron ore, coal, LNG, and crude oil. The country is now focusing on five key pillars – manufacturing, agriculture, services, education and mining – to diversify the economy.

A major challenge for the RBA is that an increased pace of interest rates will expose the vulnerable economy. As shown below, the household debt to disposable income ratio has continued to grow and is currently at the highest level in decades. If the bank moves to increase interest rates, the implications are that more people would end up defaulting, leading to a recession.