MB’s favourite rates prognosticator, Bill Evans of Westpac, is out with a note declaring that next week will be an RBA hold followed by a June cut:
The Reserve Bank Board meets next week on May 7. We expect the Board will keep rates on hold while maintaining its clear easing bias. Words to the effect of “The inflation outlook, as assessed at present, would afford scope to ease policy further, should that be necessary to support demand.”
This decision is likely to be a closely run event since we think the case for another cut has now been made. However, with rates at historical lows, we think the Board will be cautious and decide to wait another month before moving. Accordingly we are retaining our forecast that the next move in rates will be a reduction of 25 bp’s in June to a new historical low of 2.75%. We have held that forecast for a low of 2.75% since May last year.
Our current view is that rates will then be on hold through 2013 and 2014 but we recognise that the risks are clearly to the downside – recent developments have increased those risks.
Markets are currently pricing a 60% probability of a 25 bp cut in May and a 95% probability that the cut of 25 bp’s will certainly happen by June. There is a 100% probability of a further cut of 25 bp’s by year’s end. Market pricing then points to a long period of rates being on hold with a mild hint of upward pressure through 2014.
There are attractions for the Board to decide to move immediately. In particular, it would allow the staff to provide a full explanation for the move in the Statement on Monetary Policy which follows the February; May; August and November Board meetings. This timing, which also follows the quarterly Inflation Report has tended to be used more often in tightening cycles than in easing cycles. In this easing cycle to date 2 moves have followed CPI prints and 4 have come in “other” months. In the last 2 tightening cycles 10 moves have followed a CPI print and “only” 8 moves have come in other months. This is likely to be explained by the CPI being more important during tightening cycles while growth is the key influence in easing cycles.
That assertion is supported by the wording in the easing bias (see above) where the decision is seen to be dependent on the growth outlook GIVEN the low inflation. The CPI print on April 24 which showed 6 month annualised core inflation running at 2% – the bottom of the target range – confirmed that inflation allowed further stimulus although we doubt whether the print would cause the RBA to lower its inflation forecast for 2013 and 2014 of 2–3%. Data on the growth environment since the Board meeting on April 2 has been disappointing and supportive of a cut:
- a loss of 36,100 jobs and a rise in the unemployment rate from 5.4% to 5.6%.
- a slowdown in annual credit growth from 3.4% to 3.2%.
- a 5.1% fall in the Westpac Melbourne Institute Index of Consumer Sentiment
- Business Conditions in the NAB Business Confidence Survey falling to the lowest level since May 2009.
- a 5.5% fall in dwelling approvals in March to be up “only” 3.9% for the year, down from 12.7% for the year to February.
- a 0.5% fall in house prices in April lowering the quarterly increase in house prices from 2.8% to 1.1%.
- a shock slowdown in Chinese growth to 7.7% compared to a consensus expectation of 8% and a weak PMI
- a 25 bp rate cut by the ECB; QE boost from BOJ; and indications from the FED that bond buying could be accelerated
I would add more to the list:
- in the past month, the Browse LNG project has been canned and the Arrow LNG project is obviously going to be rationalised
- this is pumping out quite credible private reports of a steep declines in mining capex from the end of this year
- the PMI crashed in April, and the PSI fell sharply
- car sales tanked in April and were down year on year
- the terms so trade are down 5% or so since the last meeting and are clearly going to slide further on iron ore weakness yet the dollar has not budged
Back to Bill:
The only really strong report came with retail sales which showed a sharp 1.3% increase in February following an (upwardly revised) 1.2% in January. That retail report, however, now points to a likely very solid print for GDP and household demand growth in the first quarter with consumer spending being boosted by 1% or more.
Further, the trade price indices point to net exports adding around 0.5 ppt’s to GDP growth. More of the overall GDP story will be known by the June Board meeting when business investment and construction for the March quarter will print in late May. Of course the March quarter Capital Expenditure Report on May 30 will also include the sixth estimate for Capital Expenditure for 2012/13 and the second estimate for 2013/14. We believe it was the better than expected first estimate for Capex in 2013/14 which printed on February 28 which averted a rate cut in March and this report remains important for the Bank. The next Capex Survey will give an updated print on prospects for mining and non mining investment – how quickly is mining slowing and what prospects are there for a boost to non mining investment.
We do not envisage a Capex Report that will stand in the way of a June cut but anticipate a cautious Board awaiting that news before it moves again.
The details of the Commonwealth Budget will not directly impact the rate decision. There is no evidence over recent years of the Bank awaiting the Budget before moving. Rate moves have occurred in May 2002; 2006; 2010 and 2012 while June moves have been restricted to 2002 and 2012 on both occasions following moves in May.
However, indirectly, it appears that ongoing press coverage of the blow out in the deficit is likely to impact confidence. The Westpac Melbourne Institute Index of Consumer Sentiment Survey will be in the field after the Budget announcement for release on May 22 and it is likely that confidence will be adversely affected by the media coverage of the widening deficit. Perhaps it might be a sensible strategic approach to use the rate cut to boost confidence in the aftermath of the Budget.
Conclusion
The May Board meeting is a live event. The case is there for another rate cut. Historical precedent points to May over June. However, very important information on the state of demand will be available before the June meeting. Given that rates are at historical lows we expect that the “hurdle” for a cautious Board for a move next week will be too high. We retain our call that the next cut will be in June.
March quarter GDP is now irrelevant. The current round of easing has always been forward looking to the extent that it is anticipating the mining slowdown. Forecasts for the mining investment cliff have clearly worsened in the month and the offsetting growth areas have stalled as well. I agree with Bill Evans that the Board would prefer to wait a month but frankly the data is saying cut.
In my experience the Board follows the data. Either way, it’s coming.
