From Westac’s Bill Evans:
The minutes of the Reserve Bank Board meeting for May are used to clarify the Bank’s policy position. Recall that markets were confused by the lack of policy guidance in the Governor’s statement which was released after the May meeting. That was partly responsible for an ‘unhelpful’ lift in the Australian dollar. The Statement on Monetary Policy ( May 8) sought to partially redress that situation with: “The Board will continue to assess the outlook and adjust policy as needed to foster sustainable growth in demand and inflation outcomes consistent with the inflation target over time.” We interpreted that sentence along with the fact that the Bank had changed its forecast for underlying inflation in 2016 to be in the bottom half of the 2-3% band as indicating that indeed the Bank held a ‘soft easing bias’.
If anything the language used in the minutes has strengthened that easing bias by using the term: “Members did not see this as limiting the Board’s scope for any action that might be appropriate at future meetings”.
There is also an important lesson ibn the preceding paragraph for those of us who follow RBA policy. In describing the decision on whether to cut at the May meeting or wait until June the minutes note: “Members acknowledged that the challenges of communication might be more effectively met with a reduction in the cash rate at this meeting”. This point about communication is very important. The communication referred to is the Statement on Monetary Policy which is released three days after the Board meeting in February, May, August and November.
In effect, if there is a close decision at Board meetings in any of these months the minutes are implying that not moving complicates the commentary in the SoMP while moving allows adequate coverage to explain the decision in a more comprehensive way than in the Governor’s statement. The SoMP also provides the opportunity to reassess the Bank’s forecasts. If for instance as we saw in May the Bank lowers its growth rate forecast from 2.75% to 2.5% (2015) and its inflation forecast from 2.5% to 2.25% without making a policy adjustment the commentary is awkward if the intention is to move in the next month.
The reasons for the reduction in the growth outlook are around a changed view of the future of both mining and non-mining investment. The minutes note that “investment intentions for 2015/16 from the December quarter ABS Capital Expenditure Survey as well as business liaison by the Bank” triggered a reassessment of the investment outlook. Essentially the downturn in investment was expected to be deeper and recovery slower.
The Bank is a little uncertain about the outlook for the labour market. It has been surprised that the unemployment rate appears to have stabilised around 6.2% despite the economy operating below trend. One explanation for this is the very weak growth in wages. However the minutes still point to forward indicators of labour demand continuing to suggest modest growth in employment and therefore a further increase in the unemployment rate.
The policy response for the rest of this year will be heavily dependent on that particular expectation.
The ongoing below trend growth performance and extended period of slow wage growth has led the Bank to lower its outlook for underlying inflation in 2016 from 2.5% to 2.25%. That is significant given that they note the likely further fall in the exchange rate. In effect that is saying that inflation is no constraint on further cutting rates if it is seen to be necessary to support the recovery, particularly in household consumption.
There is more discussion around the outlook for housing. The minutes point out that outside Sydney and Melbourne (around 60% of Australia’s dwelling stock) housing price growth had declined. Sydney and Melbourne are described as “strong” but the minutes note that “the Bank would continue to work with other regulators to assess and contain the risks arising from the housing market”.
We also see a robust defence of interest rates as a policy to help demand. The rate cut was expected to “provide some additional support to economic activity by reinforcing recent encouraging trends in household demand”. As was noted in the Governor’s statement, the Board expected that further depreciation of the AUD seemed both likely and necessary.
The outlook
As discussed, the guidance in these minutes is a little stronger than the “soft easing bias” which we noted from the Statement on Monetary Policy. There is a degree of comfort around the housing outlook; ongoing concern about business investment; modest forward looking indicators of labour demand; and an inflation forecast in the bottom half of the target band.
For us the key will be progress in the labour market in 2015 and prospects for economic growth in 2016. Clearly the Board is a little puzzled as to why the unemployment rate has not edged up further in the face of clearly below trend growth in 2015. However, it is expecting that upward drift to resume in the second half of the year.
It is also expecting that the solid recovery in household spending in the December quarter will continue through 2015 justifying the above trend growth forecast for 2016. Any slippage in those dynamics or a faster than expected lift in the unemployment rate would trigger the risk of a policy response but probably not before November when these trends could be clearly identified.
On the other hand, stability in the unemployment rate and an ongoing lift in household expenditure would ensure steady policy.
For us, an important aspect of these minutes is that the Board is in no way implying some sort of natural 2% floor to the cash rate. For now, however we are comfortable to maintain our call that rates will remain steady until there is further evidence around the trends in unemployment and household expenditure.
Consistent with our assessment of a soft easing bias we see the risks to the cash rate outlook as clearly to the downside.
