Goldman sees fading growth, more rate cuts

Tim Toohey has a note out this morning with which I very much agree:

The RBA retains a clear easing bias but left rates unchanged in July – apparently as it waits to let the dust settle on the recent volatility in global financial markets and fall in the A$ (ahead of today’s decision we characterized a cut as a 50/50 proposition). Although large portions of the brief statement were a carbon copy from last month, we interpreted dovish implications from the way the RBA… We continue to see a strong case for further easing in the near term, given i) the fall in the AUD has been accompanied by several factors which are debilitating for growth, ii) weak economic momentum, iii) intensifying headwinds to growth (from an earlier peak in the investment cycle), and near term downside risks to inflation. We place our rates forecasts under review pending tomorrow’s scheduled speech by the RBA Governor (his first since early April).

Key changes: In our view, there were three changes to the statement that have incrementally dovish implications:

1. Caution on global markets: In contrast to last month when the RBA highlighted that funding conditions remained “very favourable”, today’s statement adopts a far more cautious tone. The RBA flags a “noticeable rise in sovereign bond yields”, increased volatility on financial markets, and “some widening of credit spreads”. We were surprised that there was not a more explicit mention of the recent liquidity issues in China, as it is hard to believe that these developments were not also discussed at the July Board meeting.

2. Lower levels of mining investment: Reflecting on recent below trend rates of growth, the RBA noted that “this is expected to continue in the near term as the economy adjusts to lower levels of mining investment”. We think this is a subtle but important change, because to date the RBA has been characterising levels of mining investment as “plateauing” over the next year, and to the degree that its forecast peak is lower and earlier, this clearly has dovish implications for rates. This shift in tone is also consistent with the important change in emphasis we detected on this topic in the June Board Minutes.

3. Benign inflation despite weaker A$: The RBA has been explicit on its view that the two-year inflation outlook remains benign, “notwithstanding the effects of the recent depreciation of the exchange rate”. This is an important signal that the RBA is not particularly worried about a potential run-up in tradeables inflation as a result of the recent fall in the A$ – and consistent with the analysis we published on this topic last Thursday, we continue to see the near-term inflation risks as skewed to the downside (see Australia and New Zealand Economic Analyst: Antipodean Inflation – A Softer Underbelly, 27/6/2013).

A few things to note on the last chart. For anyone who read yesterday’s optimistic CBA report, notice that GS has included all net export effects and is still registering an elevated recession risk in 2014. Notice as well that it actually has a quite aggressive interest rate response factored in eventually, which I think remains questionable and is why I continue to see rates reaching 2% or even below, as well as a much lower dollar