It’s the oldest trick in the book. When the data turns against you, discount it. From Bill Evans at Westpac:
As expected, the Reserve Bank Board decided to leave the cash rate unchanged at 2% today.
Of most interest has been the choice of words in the concluding paragraph as to whether the Board would adopt a more explicit easing bias than had been implied in the recent May Board minutes. Recall that in those minutes the Board indicated “Members did not see [actions] as limiting the Board’s scope for any action that might be appropriate at future meetings”. This time a moderation of that theme has been chosen: “Information on economic and financial conditions to be received over the period ahead will inform the Board’s assessment of the outlook and hence whether the current stance of policy will most effectively foster sustainable growth and inflation consistent with the target”. From our perspective both statements have a similar intent. That is that the Board sees that it has flexibility to further cut rates if the circumstances require that action but is making no explicit commitment in that direction. Coupled with the inflation forecast which was released in the May Statement on Monetary Policy where the Bank is forecasting underlying inflation to be in the bottom half of the 2-3% range in 2016 we see today’s statement as equally consistent with the statement in the minutes and therefore we assess the current stance as “a soft easing bias”.
Markets were speculating as to whether the language around business investment would be much stronger in this statement relative to May. That is because a very weak Capital expenditure survey further lowered the outlook for business investment intentions, both mining and non-mining. In the event, the change has only been quite subtle. In May the outlook was described as: “a key drag on private demand is likely to be weakness in business capital expenditure in both mining and non-mining sectors over the coming year”. That has been replaced with: “a key drag on private demand is weakness in business capital expenditure in both the mining and non-mining sectors and this is likely to persist over the coming year”.
In the May Governor’s statement there was marked optimism around household expenditure. It was described as: “improved trends in household demand over the past six months”. That is now broadened to: “with household spending has improved, including a large rise in dwelling construction, and exports are rising”. In this regard a key input will be the measure of household spending in the March quarter which will print in the March quarter national accounts to be released on June 3. Note that partial data on household expenditure is only available for retail sales and motor vehicle sales. There has been a large historical discrepancy between the retail sales report and the retail component of household expenditure and there is little partial information available for household services expenditure which represents more than 50% of household expenditure. Westpac expects a print of 0.7% on household expenditure which, following the 0.9% print for the December quarter would show an encouraging 3%+ annualised growth rate over the last six months. The risk is that the 0.9% gets revised down and the 0.7% proves to be overly optimistic in the face of weak income growth in that quarter. In other words, the national accounts may well cause the Bank to reassess that optimistic view on household expenditure.
There was nothing of further interest in the discussion around the real economy. It is still described as: “likely to be operating with a degree of spare capacity for some time yet” and public spending continues to be assessed as “subdued”.
The Governor restates his confidence about the inflation outlook emphasising “very slow growth in labour costs”.
The discussion around housing is unchanged from the May statement with Sydney prices being described as rising strongly although trends being much more varied in other cities. The initiative around macroprudential policies is noted.
As expected, despite the recent sharp fall in the AUD (USD0.80 in May down to USD0.76 prior to the meeting) the Governor still asserts: “further depreciation seems both likely and necessary”.
The outlook
Our call has been and remains that rates will remain on hold through 2015 and 2016. However we recognise that the Bank is making it clear that it feels it has further scope to ease rates if necessary and the critical factor is going to be the state of household expenditure over the course of this year. If the current momentum in household expenditure can be maintained then the Bank would feel reasonably confident that non-mining business investment will eventually start to respond through 2016. A sudden slowing in household expenditure would require substantial revisions to the growth outlook in both 2015 and 2016. Westpac currently expects growth in 2016 of around 3%, just enough to justify steady policy. However any marked downward revision to those prospects would have to bring policy into play. The additional dimension to this discussion is around the recent sharp lift in consumer confidence in the aftermath of the May Budget. We expect the Bank will also be aware of that dynamic and would certainly want to assess the state of household expenditure in the June quarter before making any major changes to their growth outlook. It will be also interested in the responses to the May interest rate cut and Budget measures encouraging small business investment.
In this regard we would still see the earliest possible policy response being delayed until November and any market expectation of a policy adjustment before that date seems premature.
As indicated in today’s Governors statement, the Australian dollar remains on the radar screen and Fed policy is important in that regard. We retain our long held view that the Fed will start raising rates in September creating further downward pressure for the AUD. While the AUD is undoubtedly an important part of the Reserve Bank’s objectives given its importance in moderating the impact of the recent falls in commodity prices we think the inflation outlook and prospects for the real economy will be the key policy drivers.
This is not a base case, Bill, it is an optimistic risk case. The base case is that no more policy easing will slow house prices by year end and consumption with it, that there is no material capex rebound coming because it is not needed and that the terms of trade will be hit again before year end. It’s the base case because it is what has just happened repeatedly for three years.
But that hasn’t stopped Bloxo at The Australian:
As RBA Deputy Governor Philip Lowe pointed out last week, very low interest rates may discourage investment, as firms have unrealistic expectations about future returns and have yet to adjust their investment hurdle rates to the low rate world.
Local factors could also be playing a role.
The mining boom saw wages grow faster than productivity in some parts of the economy, limiting local competitiveness. Although wages are now growing at slower rates than inflation, this adjustment is taking time and the perception remains that Australia is a high cost country.
The success from the mining boom also caused complacency among policymakers. Without a significant downturn following the global financial crisis, there was little impetus for regulatory, tax, and labour market reform. As a result, a lack of flexibility has perhaps made doing business in Australia just a little less easy.
Finally, fiscal policy has been largely mistimed in recent years.
…Having avoided many of the woes suffered by the rest of the developed world during the global financial crisis, it still seems likely that Australia’s dearth of non-mining investment is temporary rather than a more secular stagnation. Let’s hope so.
Or Fabo at the AFR:
But ANZ’s senior economist Justin Fabo has another take on it.
He doesn’t think it’s as bad as what the data indicates about the outlook for spending by the non-mining sector.<
For sure, the outlook is subdued, but perhaps just not as bad as some economists thought.
Fabo has told clients not to get too negative and highlights that the early estimates of spending from non-mining companies for the coming year can be “unreliable and different approaches to crunching the numbers can yield wildly different predictions.”
A major reason why he is wary about the latest capex survey is it covers only two-fifths of total non-mining business investment and this share has fallen over time.
For example, health and education are two sectors that don’t get a look in when it comes to the survey but both have been good at spending in recent times.
Institutionalisation on display. I’ll happily concede that the ABS capex survey has a history of exaggerating outcomes but it has no history of being wrong on trend. Rates will fall much further as the great Australian adjustment rolls on.
