Bill Evans pulls his rate cuts

Fresh from Westpac:

Our dominant theme in this cycle has been that a weak labour market would undermine consumer spending which in turn constrains investment, employment and incomes. Businesses react negatively to soft demand; an uncertain global environment and a “still high” AUD. Those forces are expected to be complemented by a number of known headwinds – mining slowdown; fiscal restraint; falling terms of trade and a resilient AUD as global growth, including in the US, disappoints.

We still see those forces operating to moderate growth and inflation pressures but now assess that better news on employment; consumption; and business confidence will dampen those contractionary forces to exclude a sufficiently strong case to cut rates. This is in the context of a high hurdle from the perspective of the Reserve Bank to further cutting rates.

Equally, however, there will be no case for higher rates for 18 months or more. Details behind this view change are set out below :

1. The upward revisions to the current state of the labour market as indicated by the February jobs report where jobs growth in February was reported as 47,300 (80,500 full time) and January was revised up from –3,700 to 18,000 painted a much more normal picture of the Australian jobs market. That meant that the dismal start to 2014 of –10,400 in the previous 3 months was revised to a modest but respectable 41,000 over the three months to February. We accept that there were probably sampling issues with this report but that revised picture of the labour market now seems more consistent with recent lead indicators of employment intentions in the business surveys (which have recently lifted). It is true that the unemployment rate was unchanged at 6% and we still expect that the unemployment rate will increase from this point to reach around 6.5% by year’s end. However, whereas before we saw the risks to that forecast to the upside they are now tilted to the downside.

2. We have been impressed by the momentum in household spending in the final quarter of 2013 (up 0.8% real); the upward revision in spending growth in Q3 from 0.4% to 0.7%; and the surprising 1.2% print for retail sales growth in January. That momentum is partly associated with the lift in Consumer Sentiment to a peak of 110 in November last year. The recent drop in the Index to 100 is indicating a slowing in that momentum in the second quarter but not to a pace that would, of its own, trigger a rate cut.

3. Public comments from Reserve Bank officials and recent written commentary point to the Bank having a “high hurdle” to cutting rates. The improved picture for the labour market and consumers has now, probably, made that hurdle just too high.

4. Offshore developments have added to the rate cut case. The terms of trade will have fallen in Q1 while the AUD has remained stubbornly high. However, due to supply constraints in the key commodity markets, we do not envisage a fall in terms of trade in 2014 much beyond 6%.

5. The Westpac Melbourne Institute Index of Unemployment Expectations has reached a 5 year high. Households are nervous about their job security and that is likely to weigh on household spending going forward providing further support for a “soft spot” in consumer spending in the June and September quarters. That is likely to keep rates on hold, although more positive trends in the labour market are likely to see that “soft spot” insufficiently threatening to warrant a rate cut.

I have lot’s of regard for Bill Evans but I’ll stick to my view that the next move will be down, largely on the back of a more bearish view of the terms of trade and the need for macroprudential policy.

Illustrating that, Bill appears to have moved the dollar!