Bill Evans pushes back his rate cuts

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From Westpac’s Bill Evans today:

We are delaying our forecast rate cuts by the Reserve Bank by three months from February and May next year until May and August next year.

While we believe the case for lower rates has already been established our forecasts for the near term have to be mindful of the thinking of decision makers.

An extensive interview which the Reserve Bank Governor Glenn Stevens conducted with senior journalists Alan Mitchell and Michael Stutchbury from the Australian Financial Review indicates quite clearly that he is in no mood for a February rate cut. The Governor will appear before the House of Representative’s Standing Committee on Economics tomorrow.

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However this session is unlikely to reveal a different approach to that described in the detailed interview with such experienced journalists. The Governor accepts the need for further stimulus in the Australian economy but he is focussed on providing that stimulus through a weaker Australian dollar rather than lower rates. Uncertainty around the residential property market is seen to be the primary constraint on using interest rates. It has been, and continues to be, our view that such an unconventional approach to policy will eventually prove to be unsuccessful. The Australian dollar is likely to remain comfortably above the soft ‘target level’ of USD 0.85 and even with a lower dollar, the core weaknesses in the Australian economy should persist.

From the perspective of the Governor the key reasons for delaying any rate cuts are (quotes are from the interview):

1. The residential property market: “we have seen an appreciable pick up in investor activity in Sydney …. people ought to be careful here”; “that (credit growth) is something we will obviously be watching over the next 6 months or so”; “for the system as a whole I don’t think, on what we’ve seen to date, that there has been a case for us to get up on the soap box about leverage. It might come and that’s why we have to watch it but thus far that would be my view”.

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We expect the residential upturn to remain constrained by affordability concerns and uncertainties around job security with significant regional disparities reflecting the impact of the mining downturn and increases in housing supply. The property upturn will continue to be fairly narrowly-based and strong price gains will be difficult to sustain as demand reacts more swiftly to deteriorating affordability. From a policy perspective the data available between now and the February Board meeting will be significantly affected by seasonality, making it very difficult for the Governor to assess the market over the next few weeks.

Importantly, we do not expect the current house price surge to generate the sort of ‘wealth effects’ we have seen in the past with households instead expected to maintain their relatively high savings rates and a restrained attitude towards borrowing. Consumer demand will remain subdued as a result.

2. Non mining investment: “On non resource sector investment, it is still quite flat and I think the outlook in the near term is for more of that … it always seems to be the case in most cycles I can remember that you’re waiting a fair while for that upturn to come, but eventually does come and it quite often comes with a rush when it does turn”.

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It is our view that prospects for a marked pick up in non mining investment are further off, than implied by the Governor, particularly without any support from monetary policy. While not denying the existence of the business cycle we expect that as has been the case in Australia and globally, the aftermath of the Global Financial Crisis is proving to be more damaging and persistent than “most cycles”.

3. On the need for tapering, “I am reluctant to speculate about nightmare scenarios openly but if they all keep doing QE forever does there come a time when we see interest rates just keep trending down and we end up in the same place as them”.

Our core view is that economic conditions will not warrant tapering until 2015. However, should the FOMC make an early start, the tapering process will prove a much more protracted process than is currently anticipated. With tapering largely already priced into both bond and currency markets we do not expect significant “relief” from the advent of an earlier than expected tapering.

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4. On market pricing of the probability of a cut in February, “We’ll see when we get to February but, really, the curve doesn’t embody all that much more easing now. A partial chance of one”.

Market pricing has been volatile. A few weeks ago the markets were giving a 50% probability to a rate hike by the end of 2014. It is now pricing in a probability of around 70% for a cut by August.

5. On the near term outlook, “We have seen some lift in confidence over recent months … it’s too early to say that will be sustained but there are some promising signs… housing … some quite clear signs of construction starting to turn up and most of it’s still ahead”.

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We accept that an upturn in new residential construction, especially in Sydney, can be expected but the national accounts for the September quarter painted a very bleak picture for household spending; renovation spending; non mining investment; and government spending while even exports faltered in the quarter. Business and consumer confidence have lost the “bounce” we saw post election. The MYEFO report is expected to further undermine both business and consumer confidence while signalling further restraint around discretionary government spending (excluding infrastructure).

6. On AUD and ‘jawboning’. “To the extent that what I or others have been saying has nudged the exchange rate down of late, I’m not sure we should take all that much credit, because I think the truth is that, in these markets, what happens elsewhere in the world and particularly what the Fed might or might not do or say… all those things matter quite possibly more than anything we say”.

7. On the particularly weak September quarter national accounts, “I don’t think for us there was any great surprise in the September quarter data when they came out … a year ago we were saying growth in the range of two and a quarter to three and a quarter … we are going to be in the bottom of that range”.

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We hold the view that with the RBA forecasting growth to be 2.25% in 2013; 2.5% in 2014 (both below trend) and a gapingly wide range for 2015: 2.75% to 4.25% there is a case for more conventional stimulus. We can see from the Governor’s current position that it is not going to be acted on in the near term.

Overall the need to assess whether a credit fuelled property boom emerges; await the ‘fate’ of the AUD; and track residential construction points to the Bank delaying the next rate cut until later in 2014. However we strongly defend our view that ongoing reluctance of business to invest and employ will ensure further weakness in the labour market which will weigh on household spending; contain any excesses in the housingmarket and signal the need for even lower rates over the course of 2014.

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.