Don’t say I didn’t warn you. JPMorgan is out forecasting rate cuts in every meeting for the next four months (three cuts). Here’s what they say:
It now looks likely that the RBA’s quarter point rate cut on Melbourne Cup Day will not be an isolated affair. Indeed, in a change of forecast, we now expect the RBA to trim the cash rate another 25bp at the next Board meeting on December 6, and by a further 50bp in the first quarter of 2012. The RBA Board showed its hand on Cup Day by choosing to ease policy owing mainly to escalating global concerns, almost despite its own staff forecasts, which still show above trend growth in Australia and core inflation tracking in the upper half of the 2-3% target range.
Our assessment is that officials will stick to this script in the near term, given that conditions in financial markets have deteriorated materially since the last Board meeting. There could be deeper cuts in 2012, taking the cash rate below 3.75%, if conditions in Europe, in particular, result in disruptive global credit events. Further turmoil in the Eurozone would raise the risk of even weaker growth in the global economy, damage the prospects for Australia’s major export markets in Asia, and threaten the functioning of financial markets.
Our call for a further 75bp of rate cuts is modest relative to the cuts in 2008-09, when the RBA took the cash rate down by more than 400bp to a record-low of 3%. The risk of even more aggressive action from the RBA this time, though, is rising by the day. RBA officials clearly have significant interest rate ammunition at their disposal, a luxury not shared by many other central banks, and their actions a few weeks back show they are prepared to use it. Officials increasingly seem prepared to move on a “balance of risks” basis, and the balance of risks is shifting to the downside by the day. There are a number of reasons for this forecast change.
• Turmoil in Europe. Australia sends less than 10% of our exports to Europe, so the direct impact of the recession there is modest. The sovereign troubles in Europe, though, clearly are having a serious and lasting impact on global financial markets and economies. Sagging equity markets, for example, damage household wealth for Australians. This, and the apparent policy inertia in the northern hemisphere, is weighing on consumer and business confidence, which is changing hiring and spending decisions in a material way. Employment here, for example, has been broadly flat so far in 2011, despite a swelling longer term investment pipeline. The growing risk now is that dysfunction in financial markets could put more stress on funding markets in Australia, which would be a serious new transmission mechanism, via the banks, of the troubles in Europe to real economic activity in Australia. Cutting the cash rate would not necessarily help directly in this regard, but it would reinforce the perception that the RBA was “on the case” in easing domestic financial conditions, in much the same way as the RBA’s aggressive official rate cuts in 2008-09 helped shore up plunging corporate and consumer confidence.
• Tighter fiscal policy. The federal government seems poised to announce additional expenditure savings in the upcoming Budget update. These savings are necessary to help the government adhere to its promise to deliver a surplus in the next fiscal year. Government officials have been steadfast in keeping alive this commitment to delivering a surplus, despite now having the plausible excuse of being able to blame the Europeans for their capitulation. Revenue collections have fallen short of target, so the government has been forced to make even deeper cuts to expenditure. These cuts will be an additional drag on growth in the economy, but the likely improvement in the Budget position would allow scope for looser monetary policy and, hopefully, lower AUD, which should help the government’s revenue collections. The government’s self-imposed restraint means that, unlike in 2008-09, when fiscal stimulus also played a material role in supporting the economy, the burden this time will be carried solely by monetary policy.
• High AUD. Although AUD dropped back below parity this week, and also has fallen in trade weighted terms, helping to ease financial conditions, it remains at an elevated level that renders much of Australia’s struggling manufacturing sector uncompetitive. Cutting the cash rate again would further diminish Australia’s interest rate advantage, and weaken one of the key supports for AUD. A lower AUD will not save Australia’s beleaguered manufacturers and tourism operators, but it would help ease the pain.
• A less problematic domestic growth and inflation trade off. We are pushing through modest downgrades to the growth forecast for Australia for 2012. Previously, we expected growth of a trend(ish) 3.4%, but we have trimmed this forecast to 3.0%, mainly on the basis of an even more cautious consumer (growth in labour income will be sluggish in 2012), slightly softer non-mining business investment, and a less upbeat outlook for exports, given the weaker global growth profile. This means the pressure on the economy’s resources will be less intense than we had expected, such that the upside for inflation should be capped. We still expect core inflation to track in the upper half of the RBA’s target range, but officials already have shown they are prepared to ease policy into such an outlook. Last week’s benign quarterly economy-wide wages data confirmed that the bounce in wage costs we had anticipated has not materialized, which greases the wheels for further easing by the RBA.
• History. In the modern era of inflation targeting, the RBA has never changed the cash rate just once in either direction; the first move always has been followed by at least another move in the same direction. Indeed, for what it’s worth, given the unusually high levels of uncertainty, monetary policy history in Australia indicates that the Board usually adjusts policy in multiple moves over an extended period, usually years, rather than tinker around at the edges to get the policy setting “just right”. It would be unprecedented, then, for the RBA, having cut the cash rate earlier this month, to not do so again.
This report stimulated a very excited story in the SMH. Sadly, it does not live up to expectations. Although I think this outcome is quite possible, to my mind JPM has misread the RBA. The bank cut rates recently in the most begrudging manner possible. From the recent Minutes:
The case for an easing in policy was that there had clearly been material changes to the recent course of, and outlook for, underlying inflation over recent months, while the downside risks for the global economy had increased. While the financial conditions that had been in place over the past year had helped contain inflation pressures in the economy, with the change in outlook that stance was no longer necessary. A more neutral setting would, on this view, be compatible with achieving sustainable growth and inflation consistent with the target over the period ahead.
There is nothing in there about accommodative policy, which JPM is dramatically forecasting.
Now, as I said on Monday, I do think it’s possible we’ll see some big cuts forthcoming, but it will be for one reason only if it happens in December, to relieve bank stress. If there’s no stress, there will be no cut. That’s why I’ve argued if they go, they may go 50bps. Even so, it’s hard to believe this would be necessary so soon after the failure of covered bonds. This is a live issue and I’ll cover it right up until the December meeting. Full report below:
JPM_RBA Forecast Change – Another Rate Cut in December_ More in 2012_2011-11!22!730068
