RBA meeting preview: Expect another rate cut

From Bill Evans, chief economist at Westpac, who believes that the RBA will cut rates by another 0.25% at Tuesday’s meeting and will adopt an easing bias:

The Reserve Bank Board meets next week on March 3. We expect that it will decide to cut to overnight cash rate by 25bps from 2.25% to 2.00%.

On December 4 last year we forecast that the Bank would decide to cut the cash rate by 25bps at both its February and March meetings. At that time market pricing put the probability of consecutive rate cuts at around 15% with the probability of the February rate cut alone (that has since been delivered) at only around 20%.

Even two cuts by May, which is now priced at 100%, was only given a probability of 28% at that time. Throughout the whole of 2014 the Bank had persisted with steady rates and forward guidance of: “the most prudent course is likely to be a period of stability in interest rates.” It was always going to take a considerable change in assessment of the economy to justify such a policy reversal. Cutting only once seemed to be too timid a response.

Arguments that the Bank would wait to assess the impact of the February cut overlook central banks’ assessments that monetary policy acts with a long and variable lag.

It is more likely that the Bank has assessed that the situation has changed sufficiently that at least 50bps of cuts are going to be required. The need to trade off risks of over-stimulating the Sydney property market with the need to contain the rise in the unemployment is likely to have been resolved in favour of the labour market.

Under those circumstances waiting for a month or two would seem to be a sub-optimal strategy.

The Bank justified the February rate cut on the basis that consumption and non–mining investment were taking longer to recover than had previously been expected. This meant that growth was taking longer to return to trend (3-3.25%) than had been anticipated throughout 2014. In turn, a longer period of below trend growth implied that the gradual rise in the unemployment rate would persist for longer and the rate itself would peak at a higher level.

The RBA’s forecasts in its February Statement on Monetary Policy further supported the view that the Bank expects that more than one cut is required to return the economy to trend growth. Those forecasts included the expectation that growth in 2015 would return to 3% under the assumption (market pricing on February 5 when the document was finalised) that the cash rate would fall a further 38bps, including 10bps in March.

Developments since the February rate cut have strengthened the case for a cut in March. On February 12 the employment report printed an increase in the unemployment rate from 6.1% to 6.4%. While that sharp jump should correctly be interpreted as partly monthly volatility, it would have confirmed to the Bank that the unemployment rate had not peaked. Recall that from October to December the rate had fallen from 6.3% to 6.1% potentially creating some doubt around the RBA’s expectation that unemployment would continue to rise.

The quarterly Capex survey, which was released on February 26 and provides the best assessment of likely progress in the rebalancing of the economy away from mining towards non-mining investment, showed a 12.4% fall in investment expectations in 2015/16 compared to the first estimate for 2014/15. Further, the outlook for services investment in 2015/16 points to a 7% fall compared to an 11% lift over 2014/15.

On the other hand, we saw a strong 8% increase in the Westpac-Melbourne Institute Index of Consumer Sentiment driven largely by the February rate cut and the 20% fall in the petrol price since late 2014. Perversely, this positive sentiment response may encourage the Bank to move again given that the Governor has been on record as being concerned that cutting rates might undermine the very confidence they would be aiming to boost.

We also saw the February meeting minutes which revealed that the Board had considered whether to cut in rates in February or wait until its March meeting. Some readers interpreted that as signalling an ‘either/or’ approach that ruled out successive monthly moves. However I think it is better to assess this discussion as the Board feeling uncomfortable with the public perception of a sharp turnaround in stance between December and February. Indicating that March had been considered and explaining that February was preferable timing from the perspective of communication is a simpler and more logical explanation.

And then we have the Australian dollar.

The Governor pointed out in December that he saw the AUD needing to fall to USD 0.75. Our own estimate of fair value puts the AUD at around that level. Prior to the rate cut in February the AUD was trading around USD0.78. Immediately following the cut the AUD traded down to USD0.765 although that level proved to be unsustainable in the near term.

That was probably because the Governor gave no guidance in his statement, leaving the market with the perception of a neutral bias. Since then the AUD recently traded around USD 0.79 and is currently around USD0.785. Markets are currently pricing a rate cut next week with a probability of 50% so no move will probably further boost the AUD.

From my perspective the key to the decision next week will be whether the Governor sees the cash rate as having a natural ‘floor’ of 2%. In that case cutting rates next week with an associated neutral bias might see markets assessing that the Bank has exhausted its rate cutting capacity. Such an assessment would be dangerous from the perspective of holding down the AUD.

My view is that the better approach is for the Governor to assess that he still has ample scope to cut further. Certainly from the perspective of the response of businesses and households to the historically low rates in 2014 and the ‘negative to zero’ policy rates in other countries there is no justification for a 2% ‘floor’.

The policy approach to ensure maximum easing in financial conditions would be to cut rates by 25bps and adopt an explicit easing bias. That bias might not need to be acted on but such a policy would ensure maximum downward pressure on the AUD.

We recognise that anticipating the month to month preferences of the Governor and the Board are fraught with danger. What we can be absolutely certain of is that the cash rate will be reduced by 25bps by May this year. That said, the best policy is to cut by 25bps in March and adopt a clear easing bias. In these circumstances it is best to forecast good policy rather than angst over ‘second guessing’ what might happen.

Comments

  1. “… at least 50bps of cuts are going to be required.”

    Required to… do what Bill? Push on the string further no real economic activity but continue to allow increased debt for mortgages and allow the over-geared to continue to hold? *golf clap*

    Gotta love how the performance of the RBA is never analysed, just what the magic number will be each month.

    • Why should we care that investor mortgage debt is rising along with house prices in Sydney and Melbourne? Presumably it adds to the risk of systemic instability down the track? And why should we worry about systemic instability? Presumably because it will curtail economic activity and drive up unemployment rates.

      What will happen if the RBA raises interest rates? The nominal exchange rate will rise and the labour market will be forced to shoulder the full burden of adjustment as national income recedes, meaning higher unemployment rates.

      Since there is no way of supporting employment levels if we decide to leave the burden of adjustment with the labour market, and since there are targeted ways to stymie risky lending aside from the bludegoning the entire economy with high interest rates, there is simply no sound case for not utiilising monetary policy and the nominal exchange rate as the means of adjustment.

      • “Since there is no way of supporting employment levels if we decide to leave the burden of adjustment with the labour market, ”

        Government spending can support employment levels, we don’t need to “leave the burden of adjustment with the labour market.”

      • Only in the short-term. If the government supports the labour market while the nominal exchange stays high, it can only do so with increasingly wide budget and current account deficits. This it can manage for a while yet but such a strategy would be extremely risky as the federal balance sheet is the backstop for the entire bloated banking system.

        More importantly, increasing government spending will have a minor impact on Australia’s competitiveness, even if it is well-targeted to raise productivity. The real exchange rate adjustment that Australia needs remains huge, in the order of 20%. Infrastructure spending simply cannot raise productivity enough to negate the need for that adjustment.

      • Systemic financial instability goes further than unemployment. and IMO is much more important. This is why I care about addressing hyper-debt for the country.

        Also there’s far better ways of managing the exchange rate as @pfh007 comments on via capital controls and regulations.

        Unemployment is almost certain to increase – and you know what, it probably is required until all our wages nominally fall and the ripple effect to housing and other cost of living things happen. I’m sure Mr Keating could come up with a “we had to have” line for this and I’d be nodding my head.

        The other side of the coin is fixed income types and savers. Our income has been hyperinflated away (with house prices as a the measure) and by more “official” means is negative-real, and worse after tax. So what happens? Deflation. We can’t afford to spend 1c more than we have to because it’s not there to spend! Raise savings rates (preferably via mortgage 300bp fee) and pass on to savers directly, tax free. There’s your stimulus.

      • mjv While I agree with your general take here this bit bothers me a lot
        “there is simply no sound case for not utiilising monetary policy and the nominal exchange rate as the means of adjustment.”

        There is a sound case NOT to use monetary policy and exchange rate adjustment. Using lower interst rates to achieve a lower ewxchange rate is a nonsense. Here we are a nation with a chronic CAD wanting to lower interst rates to stimulate consumption while trying to hammer the exchange rate.
        We don’t have savings for investment.
        So we need higher interest rates being significantly positive RAT. We DO need a lower exchange rate. Evans’ 75c as fair value is laughable if it wasn’t such a serious matter.
        The answer lies in control of the flow of funds in the external capital account. There are a variety of ways of achievoing this but any slowing in those funds will quickly bring about an exchange rate adjustment of the type required.
        The question of whether the nation can accommodate such an adjustment in its present state is open to debate.
        My signature ‘The answer lies back in time’ still holds. However if we are not to abandon all hope we must try.
        Fiddling with interest rates to adjust the exchange rate is just avoiding the real issues.

      • Why is systemic risk more important than output and unemployment levels? What is the risk that you find so much more concerning?

        Capital controls are a more tenuous option than tightening the screws on mortgage lending to investors. Having an open capital account is desirable so long as imported capital is being wisely allocated within the economy.

        The entire basis of opening the capital account is so that the nominal exchange rate can absorb shocks instead of domestic prices. Why would you want to inflict high and protracted unemployment on the economy for as long as it takes nominal wages to adjust, when you can achieve precisely the same outcome regarding competitiveness via a swift nominal exchange rate depreciation? It’s pure masochism.

        It is also inherent to complain about the lack of passive returns to ‘savers’. Where do you think the returns to savers earning fixed income in Australia come from? The only reason interest rates are has high as they are in this country today is because of the huge private debt burden which has been accumulated in recent decades. Without this demand for credit, overall spending in the economy would have been far lower over the duration of the credit boom and market rates would have been lower. As a saver relying on fixed income from bank deposits, you are relying on the huge private debt burden for your income.

      • Hello flawse, apologies for not replying yesterday.

        I understand your concerns entirely. My view is simply that the credit expansion in this country, the misallocation of foreign capital into unproductive domestic uses is really about a narrow sector of the credit markets. By all means, control the flow of funds towards the purchase of existing dwelling for investment purposes, but do so with bank regulations and tax reform.

        Raising interest rates to stimulate national savings in the current context is somewhat self-defeating. Higher rates will drive up the nominal exchange rate. This reduces the net flow of income into Australia, making it harder to balance the current account, assuming it remains open. The labour market will deteriorate, further pressuring households’ capacity to save in aggregate.

      • mjv
        “The entire basis of opening the capital account is so that the nominal exchange rate can absorb shocks instead of domestic prices.”

        mjv I understand that is how the morons(or are they ther eally smart people who are REALLY running this country) trumpet the virtues of the FFFFFFEFR. So what we have done for SIX decades continuously is to borrow and sell assets to avoid adjustment in our prices – be it proices of imported goods, wages real estate whatever. We just borrow and flog our assets to cover our excess consumption. As long as we continue with this we are surely heading into a corner from which there is no escape. We WILL one day sooner or later run out of saleable assets to flog. We will then be left with a chronic,severe and out of control CAD, no assets of any worth, very high inflation and interest rates somewhere out past Saturn.

        ” the nominal exchange rate can absorb shocks”
        This damned notion that the floating exchange rate has saved us from major dislocation of the economy is just so much c..p! (Sorry – but I just can’t believe the wool that has been pulled over everyone’s eyes in this matter)
        It’s our being blessed with such a vast array of natural resources that we are prepared to flog to finance our sense of over-entitlement that has been the shock absorber.
        If we keep going the way we are going we WILL end up where we are headed.

        As I’ve posted enough the decision to float the dollar was hotly debated at the time especially by ex Treasury Secretary John Stone (and a variety of others) The predictions, by Stone, made back then as to what would be the result have proven to be remarkably prescient. We are more or less exactly where he said we’d be

      • No problem mjv! You at least argue rationally!

        Hopefully we agree that what is now going on is unsustainable. We WILL run out of mines to sell. We WILL run out of farms to sell. We WILL run out of major businesses to sell. However with a deteriorating exchange rate, as Janet rightly pointed out yesterday, this will happen at an accelerating rate. Anyone who is not totally economically and generally myopic with a long time frame will snap up resources as fast as they can. The cheaper they are to buy the more they are in demand. Zero interest rates values all inground resources as zero which is a supremely false valuation so somebody will buy them as long as we have any left to sell.
        This underwrites the exchange rate and makes the carry trade profitable 80%???? of the time. It’s not that we have to shut down all foreign investment it’s that, as you correctly observe, we have to use that money wisely – which we DON’T.
        For example, we bring it in for houses (the way HnH looks at it – I don’t) then, from there, it all gets spent on fridges furnishings cars houses machinery etc etc etc – all imported.
        Those who advocate infrastructure spending in here advoacate pretty much all of it for Sydney and Melbourne producing nothing which would allay the problems in eh external account. it would just add to our problems in that regard. To recommend infrastrucurre spending be assessed in relation to teh external account and an ability to enhance exports would, seemingly, be totally ‘uneconomic’
        We’re caught in a bind. Furhter re the adjustment in prices we have, for too long, been enjoying artificially low prices and thus artificially low inflation. It’s all so false relying totally on increasing debt of all kinds in order to sustain itself.
        P.S. I understand all the dilemnas you point out. I understand the dislocations and difficulties of changing course to a productive sustaianable economy. That’s why I’ve argued for many years that we need to start a sensible conversation around these issues. We’re not getting it!

        It has to end – but how?

        PPS – I can spell – my typing is terrible! – Sorry
        I try to fit this stuff in while running a ‘small’ business – so it is mostly a quick dash!

      • mjv
        “Why is systemic risk more important than output and unemployment levels? What is the risk that you find so much more concerning? ”

        In other than the very short term they are one and the same – as we are now finding out. Every job we produce in non-productive consumption sectors is more debt and more problems when TSHTF.
        You can’t make this better by reinforcing all the things that are wrong now. We can’t make it better by exp[anding retail to import more. We can’t make it better by building bigger flasdhier houses. We can’t make it better by drinking more coffee. We can’t make it better by having more people in government whose job it is to interfere with, what are yet, productive businesses. We are just using more debt to reinforce all our problems and make them worse and harder to solve.

        Re short and long term – for modern economists the long term is like six to twelve months. Fifty years ago short term was 12 months to 2 years (less wasn’t even worth consideration!) Medium term was 5 to 7 years and long term 10 years and more (even 30 years)
        (Again considering the real long term – like maybe a generation interval – say 25 years or even 10 years for that matter, you get a different economic philosophy entirely than trying to goose GDP over the next three months till the next RBA meeting!

      • Flawse, can you clarify something for me.

        You talk about the CAD as if its a curse.
        But it isn’t it a boon? I mean if foreigners are willing to fund us that is a good thing isn’t it?

        The problem really lies in what we spend it on: bidding against each other for houses, overseas holidays, jetskis etc.

        Therefore, isn’t there a better way of doing things than enacting capital controls to reduce the CAD?
        The CAD isn’t really the problem, its the way we waste the proceeds

        Interested to hear your thoughts

      • “You talk about the CAD as if its a curse.
        But it isn’t it a boon? I mean if foreigners are willing to fund us that is a good thing isn’t it?”

        But to run the CAD we have to sell assets.

      • So what?

        The majority of the “assets” you are talking about are dogbox apartments and red dirt

        Why would NOT want to sell these overpriced assets to foreigners

        The problems lie in what we do with the proceeds/demand for AUD

      • In any case it seems to be the desire for foreigners to acquire these assets that leads to a CAD, not vice versa

      • @Coming

        The majority of the “assets” you are talking about are dogbox apartments and red dirt

        No problem if that was the case. How many “Australian” companies are foreign owned? How much farmland have we sold off? How much public infrastructure has been privatized?

      • @ Neo – no – to run a CAD other countries must give us more of their stuff than we give them, so we owe them money.

        If our dollar falls low enough Australians will stop buying stuff from other countries because we can’t afford it, hence our standard of living will fall if we measure that standard in terms of cars and flat screen televisions.

        If you adjust the graph to begin at 1990 here – http://www.tradingeconomics.com/australia/imports
        you will see how the demand fell sharply in 2008 when our dollar fell to $0.60 USD and again you can see how in recent months the import level has moderated due to the falling value of the dollar.

        All based on the principle that as imported goods rise in cost local buyers substitute locally produced goods where they can to get a better deal, which then employs more people in Oz.

        It works the opposite way for exports as you can see here – http://www.tradingeconomics.com/australia/exports (1990 to 2015)
        but of course we are losing export income in mining exports so that rebalancing may require a longer adjustment period.

      • @Coming

        No its not. We are not getting something for nothing. Foreigners don’t just give us money and take what we give them, the buy up the best assets.

        But it isn’t it a boon? I mean if foreigners are willing to fund us that is a good thing isn’t it?

        It’s not a boon if you are selling farmland to fund it.

      • @ FF

        We can choose to sell our farms or we can choose not to. Nothing to do with the current account.

        Whether we have a CAD or CAS it’s made up of millions of transactions both ways, and if foreigners decide to extend us credit on what we buy then it’s not tied to a farm sale, it’s based on a judgement call that we can make good in foreign currency or goods for them to buy in exchange. If we don’t pay they stop extending credit, just as any supplier would.

        All we have to do is limit what foreigners can buy, if that is in our interests, knowing that we also buy assets in other countries, so there will always be a little give and take, as long as it’s in balance.

      • We can choose to sell our farms or we can choose not to. Nothing to do with the current account.

        The cognitive dissonance must be driving you insane.

      • Hey Flawse,

        Just on your point re. asset sales. You probably won’t want to hear this but, asset sales to fund the CAD really isn’t the problem, borrowing is the problem. Pretty much all of our negative investment position is due to accumulated debt. Our international equity position is basically balanced I’m pretty sure. So why don’t you focus on the borrowing problem?

      • Whatever helps you sleep at night Peter.

        The fact remains that we are not getting something for nothing as Coming keeps trying to tell us.

  2. The RBA wouldn’t be cutting to give a jolt to the sagging fortunes of Abbott and Hockey would they? No, of course not! Wouldn’t be trying to help their desperate paymaster would they? Oh no, this is all about doing the ‘right thing for the economy’. Absolute bull. Is there any institution this government is going to leave uncorrupted?

  3. I’m just hoping and holding out to see if the AUD can push back up to 80US cents before I make a purchase… But arrrghhhhhh. It just doesn’t seem to be happening!

    I’m hoping to go long on the USD, purchasing USD incremental “packets” as the AUD weakens…

    Common baby, just shoot a little higher, but I don’t think it’s going to happen. ARRRRGHHHH!

    • If they don’t cut on Tuesday, dollar should jump to around 80c. Then I would jump in and execute a short AUD. Interest rate cut should then follow in April to trash the AUD.

      • Yeah, if they hold it’s similar to a public service announcement “last chance to debark before the final destination, hell”.

  4. @ wasabinator

    I agree…

    Hmmm, I’m contemplating holding out and taking the risk. I don’t think they’ll cut, purely because I think it wouldn’t send a good picture to the wider public. I suspect they’ll hold for one more month to get a decent indication as to how things are going and where the trend really lies.

    That’s my hope anyway.

    • A thought for you all:

      December 1983.
      The whole world was short A$, expecting a devaluation ( it was fixed to a US$ backed TWI back then). Our order-board was full; stacked on the LHS with sell orders at or above market ( a white board and pen in those days!). Not one solitary order to buy A$ on the RHS. What happened? A “Swiss-like” Central Bank/Government change came out of the blue – the A$ was floated. What do you think happened on the Monday morning? ( even with a managed floating rate). The World was short A$ and and there was only one seller of substance ( and a tiny seller by chance :) ) – The RBA at whatever anyone wanted to pay them!.
      In this day and age, who knows what might happen, any day; any night. Short, when the World and his Dog are short or shorting might just be a brave move…..

  5. The environment has changed and a further cut will have little impact other than lowering the dollar slightly

    Years ago this may have been a boost to manufacturers, now these are on their last legs, our car industry is shutting down here in Vic.. the low dollar horse has bolted

    What will happen is another kick in the overseas property investor tail.. I’ve been monitoring Glen Waverley property prices for years (own there, previously lived there).. the number of sales over $3 million is unbelievable, this may have occurred once or twice a year just 5 years ago, now its every second week and all driven by foreign buyers

    Same can be said for Surrey Hills, Balwyn, ect.

    These folks aren’t bothered by mortgage rates as they are paying cash

    The locals, that aren’t bright enough to see what is happening, are knee deep in NG debt and aren’t too concerned with low yields as it gives them a greater amount to NG each year and heck, prices will go up about 15% a year, right?

    So all this cut will do is make it more attractive for overseas buyers (lower exchange rate) and get more locals in the NG race

  6. I think we can all accept that the main thing holding back consumer confidence, spending and a massive tsunami of business investment has been interest rates at 2.5% cutting them is really going to put a rocket under the economy.

    Cutting it will also slash the iron ore price greatly improving Chinese demand and creating an explosion in construction in China while also restoring our balance of trade.

    Said someone in 2001

  7. 1) the RBA looks after the banks
    2) the RBA is doing what all the other central banks are doing…providing incredibly low interest rates for government so that they can continue deficit spending during the largest balance sheet depression the world will ever see, such that government can actually pay the interest bill on its debt.
    3) the RBA copies all the other central banks, even though they realise they are copying failure, eg Japan.
    This way they won’t end their days in upside down crucifixion…because they did exactly the same as Japan, the U.S. and every other central bank.

  8. Bill Evans is probably right on this, however I think he is overplaying the importance of local data to current RBA decisions.
    Over $4t worth of the global bond market and 1/4 of the European bond market is currently in negative yield territory. These bonds now command a greater liquidity premium than cash. In this context, unless the RBA wants to see inflation collapse and the Aussie dollar remain overvalued, they have almost no choice but to keep cutting.

    • Yee-hah. I sold my house in Oz and converted to USD. I have nothing left in AUD but my kids’ savings accounts, and super.

      The only question remaining is when to stop betting against the AUD. We ain’t there yet!