More sudden consensus from Bill Evans:
Since the March meeting we have argued that the cash rate is certain to be eased by 0.25% in the April/May “window” while retaining an “April bias”(analysis of RBA’s rate decision following the March meeting.)
We are sticking with that April view while recognising that the Bank could easily defer the rate cut decision until May.
Following the February cut the Bank gave no guidance about future rate moves although we were comfortable to stick with our original February/March call.
In the event the board held rates steady in March while adopting a very strong easing bias ,”it was appropriate to hold interest rates steady for the time being”.
Our count is that “for the time being “ has only been used in eight statements since January 2009 and on six of those occasions the Bank moved rates at the next meeting while it moved at the following meeting on the other two occasions.
On that basis a strong case can be made for an April move.
However, as usual, it is more complicated than that. Note that February, May, August, and November (“quarterlies”) are popular times for the Bank to move. These months immediately precede the quarterly Statement on Monetary Policy (SOMP) and follow the Inflation Report. The SOMP also incorporates the Bank’s forecasts. Recall that, back in December, we justified our forecast that the Bank would decide to move in February by emphasising that it would be attractive to be able to use the SOMP to explain its decision in detail and revise its forecasts given that rates would be lower.
Indeed on both the occasions that the Bank delayed its move by one month the months for the change were “quarterlies” – August and November. On two other occasions it moved on “quarterlies” because they were the months immediately following the meeting that used the “ for the time being” language.
However that did leave four moves (March ,June ,October, December) that were made outside the “quarterlies”. Note that only one of them – October- occurred only one month before a “quarterly”. The other three occurred two months before a “quarterly”. Arguably the two month wait for a “quarterly” was too long.
On the basis of the above historical analysis the case for waiting until May is stronger than the 25% that is implied in the “two out of eight” frequency.However the most important reason for awaiting a “quarterly” is to revise forecasts on the basis of the policy decision. That is not so relevant in this cycle because the forecasts in February were based on a second rate cut. It is unlikely that the forecasts in the May SOMP will be significantly changed.
Markets are pricing the probability of a cut in April at around 68%. That would seem decisive but recall that they were pricing in a probability of 64% for the ill-fated move non move in March.
A further doubt about the April move might come from the March board minutes. “members saw benefit in allowing some time for the structure of interest rates and the economy to adjust to the earlier change. They also saw advantages in receiving more data to indicate whether or not the economy was on the previously forecast path.”
Literal reading of that statement might immediately eliminate the April option but that overlooks the likelihood that central banks use such statements to justify a current decision rather than provide forward guidance.
From our perspective we think that this statement mainly referred to the December quarter national accounts which printed the day after the board meeting and showed a disappointing 0.5% GDP growth for the quarter.
The “interest rate argument “seems less supportive of a further delay given that we have always maintained that a total of 50 bp’s will be required and that the Bank assumed 50 bp’s in its forecasts for the February SOMP.
Compounding the justification for moving next week has been the surprise15% fall in the spot iron ore price since the March board meeting. Over that period the AUD has only fallen by around USD1¢.
That is why it will be important for the Bank to maintain an easing bias when it announces the cut next week. The bias will not need to be as “strong” as the bias in March but may take a looser form like, “ the Bank has scope to cut further.”Such language will not commit the Bank to any immediate follow up moves and can be credibly maintained for some time.
It will, however, maintain downward pressure on the AUD.
So, why are we not forecasting a further cut beyond April along the lines of market pricing
We think the Bank will be patient with its next moves. It is getting closer to the “lower” bound on rates (could be around 1%) and will need to retain some ”ammunition” in case of an unexpected shock.
Further, that it is currently forecasting that growth in 2016 will be 3-4% (based on only 50 bp’s of rate cuts). If it starts to lose confidence in that above trend forecast as a result of lack lustre growth in the second half of 2015 to a point where (as we saw last year) it is forced to forecast another “below trend” year of growth in 2016 then it will have to take further action. That action would likely be, not the 25 bp’s currently embedded in market pricing, but another 50 bp’s along the lines of what we are seeing in the current cycle.
We can certainly see downside risks to the 3% + growth rate scenario for 2016 but at this stage are prepared to “go along” with a more optimistic outlook for 2016 than 2014 and 2015 (both around growth rates of 2.5%–2.75%) and forecast steady rates for the remainder of 2015 and beyond.
Consider the improved environment so far this year. The AUD averaged USD 0.90 in 2014 compared with USD 0.785 in 2015, to date. Mortgage rates will be 50 bp’s lower for most of 2015. The Westpac–MI Consumer Sentiment Index has lifted to 100 compared to an average of 96.5 in 2014 and we expect a modest lift in the world growth rate in 2016 from 3.5% in 2015 to 4.0% in 2016.
Of course risks around the labour market, asset markets, FED “normalisation” and commodity prices coupled with an acceleration in the downturn of the mining boom will continue to be headwinds for 2016.
For now, we are comfortable to continue to expect a rate cut next week of 0.25% to be followed by a period of stability marked by a clear easing bias.That bias will be maintained until the Bank gets a more accurate insight into the sustainability of its current 3.5% forecast for growth in 2016.
And from Mr Joye:
“First, the possibility that a dovish US Federal Reserve may defer its inaugural hike and hence the normalisation in Australia’s exchange rate, which the RBA is desperately seeking to compensate for the slump in our terms of trade.
“A second important factor is the substantial deterioration in reported business capital spendingplans, which was worse than the RBA’s forecasts had assumed.
“The third event has been a sharp fall in commodity prices, with the US dollar price of iron ore now down 16 per cent since the RBA’s board last met. This has not been neutralised by a commensurate decline in the Aussie dollar, which is trading at US76.6 cents and only off 1.5 per cent over the same period.
Seems to be a sudden consensus emerging. 2 year bond yield just hit another new all time low.
