Australia’s best bank economist dissects the Statement and sees plenty more cuts in the pipeline. I agree.
As expected by Westpac the Reserve Bank Board lowered the cash rate by 25bps to 3.5%.
Relative to the statement in May there has been a series of observations around the world economy and the domestic economy that suggest to us that the Bank is prepared to cut rates significantly further.
On the international front, whereas in May the Governor assessed that “financial market sentiment has generally improved” he now notes that “financial market sentiment has deteriorated”; that “spreads have increased” and “long term interest rates faced by highly rated sovereigns have fallen to exceptionally low levels”. He refers to a further weakening in Europe. Despite the poor payroll data for May continues to describe the United States as growing at a moderate pace but does seem to be more concerned for Asia. He notes further moderation in growth in China and conspicuously excludes the qualification used in the past that this was “as intended”. He also raises,for the first time, the spectre that the slowdown in China could dampen growth in the rest of Asia.
Growth in Australia is now described as” moderate” compared to “below trend” in the May statement. While Westpac has consistently highlighted the impact of the cautious consumer on the economy, the Bank has not always recognised that factor. However a clear emphasis is given in “both households and businesses continue to exhibit a degree of precautionary behaviour which may continue in the near term”.
In May, house prices were described as “stabilising” whereas one month on the Governor chooses to point out that prices have “recently declined again”. The housing market generally continues to be described as subdued.
Of course the big data surprise since the May meeting was the fall in the unemployment rate from 5.2% in March to 4.9% in April. The Governor takes little comfort from this describing labour market conditions as having “firmed a little”.
No new data is available on inflation but the Governor does raise the cautionary note that “over the longer term [low inflation] will require growth in domestic costs to slow as the effects of the earlier high exchange rate wane”. However he does confirm the forecast that inflation is expected to be in the 2 to 3% range over the coming one to two years.
From our perspective the most important observation in the statement is the Governor’s assessment of the stance of monetary policy. In May, interest rates to borrowers were described as “close to their medium term averages”. Following the 50bp cut they are still only described as “a little below their medium term averages”. This observation highlights the Bank’s difficulties in getting traction from its policy instrument. Following the 50bp cut in May the average standard variable mortgage rate (SVMR) fell by 35bps, blunting the impact of the “large rate cut”. A small regional bank has already announced that it will cut its SVMR by 20bps. Once again partially diluting the impact of the rate cut from the Governor’s perspective.
The outlook
Last week Westpac revised down its forecast for the low point of the official cash rate in this cycle to 2.75% including the 0.25% cut which occurred today. With the policy stance still only described as “a little below average” the range of economic threats associated with the global economy; a high Australian dollar; and cautious business and households indicate to us that rates need to go down a lot further than we saw today.Our forecast is for further 0.25% cuts in July and August with a final 0.25% move in the December quarter.
