Fresh from Westpac’s Bill Evans:
In November the RBA forecast growth through 2015 of 2.5%-3.5%. This forecast has now been lowered to 2.25%-3.25%. That is, the mid-point has been lowered from 3.0% to 2.75%. This 0.25ppt loss of growth is expected to be concentrated in the first half of 2015. Forecast growth in 2016 has been maintained at 3.5% (mid-point).
These growth forecasts are significant because the revised forecasts incorporate: (1) the expected impact of the 0.25% rate cut which was announced on February 3 and, critically important, (2) “the assumption that the cash rate moves broadly in line with market pricing at the time of writing”. Market pricing currently envisages a further full 0.25% cut plus another possible 10bps.
In short, the RBA is expecting that growth in 2015 will still be below trend despite the current rate cut and the markets’ expected further rate cuts.
Growth in the year to June 2016 is still expected at 3.25% (mid-point) which is the generally accepted trend growth pace for the Australian economy. Even accepting that the forecast growth reduction is due to an extended weak spot at the end of 2014 and in the first half of 2015 (when monetary policy enacted this year can hardly be expected to have much impact) the fact that the Bank is assuming that with the recent cut along with the market’s expected cuts growth in the zone when monetary policy changes can be expected to have an impact will only reach trend, points to the need for lower rates.
Presumably if the Bank had made its forecasts on the basis of steady rates then it would have been forecasting below trend growth.
Prospects for inflation have also been revised down. In November the Bank forecast underlying inflation at 2.25-3.25% in 2015 and this estimate has been revised down to 2-3%. That is despite the assumption around the AUD being revised down from USD0.86 in November to USD0.78 in February. The Bank is confident that domestic inflationary pressures will remain subdued. The Statement notes that “the direct effects of the exchange rate depreciation since early 2013 are expected to add a little under 0.5 percentage point to underlying inflation over each year of the forecast period”. That calculation indicates that domestic inflation is expected to hold around the bottom of the forecast range.
These forecasts are a reasonable signal that the Bank forecasts that further rate cuts will be required to return growth to trend while the inflation outlook has improved despite lower rates and a lower currency.
Not surprisingly the general discussion in the Statement is downbeat. Prospects for consumption, non-mining investment and the labour market have been revised down. On the other hand the Bank remains constructive on exports and the housing market.
Note the following quotes from the Statement
(which presumably refer to the economic outlook in the wake of the February rate cut and on the assumption that the cash rate moves broadly in line with market pricing):
“consumption will continue to grow at a below average pace”;
“non-mining investment will remain subdued until at least mid-2015”;
“the lower oil prices will contribute around 0.75 percentage points to real disposable income…but will be offset by lower labour incomes than had been expected”;
“the expected recovery in non-mining investment has been pushed out to later in 2015”;
“a number of indicators suggest that spare capacity in the labour market has increased, consistent with below trend growth in the economy”;
“the unemployment rate is expected to rise a little further and peak a little later than earlier anticipated”;
“many firms expect to see a period of low and stable wage growth ahead”;
“unit labour costs will remain well contained”; and
“weaker near term outlook for product and labour markets more than offset the upward price pressures from further exchange rate depreciation”.Conclusion
Back in December we forecast a 25bp rate cut in both February and March. We expected that if the economy evolved as anticipated over the subsequent months the Bank would see the case for easing policy. Only doing one cut was considered unlikely given that policy had been on hold since August 2013. Two consecutive cuts seemed to be the appropriate approach.Today’s Statement contains forecasts that are generally weaker (in the near term) or on a par with the November forecasts but are made on the basis of a the current AUD (USD 0.78 down from USD 0.86) and the market’s expectation that rates will be cut further over the course of the next few months.
Despite that considerably greater stimulus (both realized and assumed) growth beyond the near term is not expected to be any stronger than the forecasts when the Bank was on hold. That suggests that the Bank is likely to frank the market’s expectations for at least one more rate cut.
We are comfortable that given these forecasts and the overall tone of the Statement a cut next month seems to be the most likely strategy.
I know the RBA likes to travel in pairs with its rate cuts and I fully expected another cut before today’s happy go lucky SoMP. I’ll render a view closer to the date.
