Bill Evans sees two rate cuts in 2014

As expected, the Minutes to the November RBA Board Meeting retained the key statement that “The Board’s judgement was that, given the substantial degree of policy stimulus that had been imparted, it was prudent to hold the cash rate steady while continuing to gauge the effects [of the earlier rate cuts], but not to close off the possibility of reducing it further should that be appropriate to support sustainable growth in economic activity”. The Minutes did, however, not contain the comment “nor signal an imminent intention to reduce them” as did the October Minutes. While technically this may open the door for a December move, we doubt the RBA has any imminent intention to reduce the cash rate. Rather, the Board clearly has an easing bias and they would like to highlight the fact.

The Board is “continuing to gauge the effects, including in the housing market, of the substantial degree of monetary policy stimulus that had been put in place over the past two years. There was mounting evidence that monetary policy was supporting activity in interest-sensitive sectors and asset values”. They argue that it is “too early to tell whether this improvement would signal a willingness of businesses to take on new risks and thereby add to employment and investment”.

The Board also gave some insight into why they are in a watch and see, rather than primed to go, mode. “Nationally, dwelling prices were above their late 2010 peak, with prices over the three months to October increasing significantly in Sydney. Housing turnover and loan approvals had picked up noticeably. Improved conditions in the established housing market were providing an impetus to dwelling investment, with residential building approvals increasing over the year”. This an expected development from the low level of interest rates and something the Board is hoping will spur on wider domestic activity.

So why does the Board still have an easing bias? They appear to have acknowledged concerns in regards to non-residential investment outlook noting rising office vacancy rates at the same there’s a clear decline in government employment. Downward revisions to the growth outlook have also been noted due to a stronger currency and a larger than expected fall in mining investment.

In addition, employment is forecast to continue to grow below the rate of population growth and hence the unemployment rate is expected to continue to rise gradually for the next year or two. Inflation forecasts are little changed and underlying inflation is forecast to remain consistent with the inflation target for the forecast period.

The other key reason for the rate cut bias is the Australian dollar. It was noted that “the Australian dollar, while below its level earlier in the year, remained uncomfortably high” and that a lower level of the exchange rate would likely be needed to achieve balanced growth in the economy”. No doubt the strategy of maintaining an easing bias is partly motivated by the need to “talk down” the AUD.

Nevertheless, the Board is holding to the view that “in time, non-resources business investment was also expected to increase given the low level of interest rates and recent substantial increases in measures of business confidence and conditions”.

The Bank’s forecast for growth appears to be predicated on the current housing story flowing through to consumer spending which as the Board notes “household spending looked to have remained below average in the September quarter, consistent with softness in the labour market weighing on income growth”. This is unlikely to materialise until consumers become much more comfortable with their job security.

Note also that the Bank lowered its growth forecast for 2014 from 3% (trend) to 2.5% (below trend) citing a lower trajectory for both mining and non mining investment.

Discussions on the international scene focused on the fact that Australia’s main trading partners growth remained around average. Chinese growth had lifted a little and was consistent with the Government target of 7½% while the Japanese economy continues to grow, albeit at a slower rate than the relatively strong pace seen in the first half of the year. In the rest of Asia, growth has continued around trend.

The US outlook is critical for the RBA as the tapering by the US Federal Reserve will be key factor in their desire to see a stronger US dollar and thus, a weaker AUD. The partial government shutdown in the US is expected to reduce growth only slightly in the December quarter although it is too early to tell as several data releases have been delayed. While house prices have risen further, it was noted that US housing starts and mortgage applications for purchases had declined since earlier in the year. Overall, the US economy was described as growing at a moderate pace.

Conclusion

The Bank has noted the recent strength in consumer and business confidence as well as the upswing in house prices and dwelling approvals. However, there are clear question marks on the sustainability of this upswing and if it can be maintained into 2014 given the downbeat outlook for non-residential construction; an expectation for a rising unemployment rate; the slowdown in mining; weak government spending; and the drag on our external sector from an “uncomfortably high AUD”.

There are many dimensions of uncertainty in the outlook. The Bank is looking for the wealth/employment/confidence boost from the housing upswing to feed into the weak area of the economy mainly explained by business decisions on employment and investment.

It is our view that the pass through will be slow and uneven requiring further monetary stimulus in 2014. The minutes confirm that the decision to cut is not imminent and will depend on how those dynamics interact.

We continue to expect the Bank will become increasingly aware of the need for lower rates in 2014.

It is our view, that two further cuts in the cash rate will be required in 2014.