Bill Evans: RBA tilts towards rate cuts

Via Westpac:

The RBA minutes clearly indicate that they are willing to cut the cash rate and have set out the conditions that need to be fulfilled for it to occur. We are encouraged by this new detail, and continue to believe the RBA will cut the cash rate in August and November this year.

The minutes of the April monetary policy meeting of the Reserve Bank Board have provided the clearest signal yet that the Bank would be prepared to cut the cash rate.

Firstly, the final section “Considerations for Monetary Policy” states “a lower level of interest rates could still be expected to support the economy through a depreciation of the exchange rate and via reducing required interest payments on borrowing, freeing up cash for other expenditure”.

The Board even sets out the conditions for a rate cut, “members also discussed the scenario where inflation did not move any higher and unemployment trended up, noting that a decrease in the cash rate would likely be appropriate in these circumstances”.

The Board also notes that “members agreed that there was not a strong case for a near-term adjustment in monetary policy”. We would interpret the “near-term” concept as referring to the next Board meeting in May. We do not believe that statement excludes the possibility of our target timing of August for the first rate cut.

Of course, while the Board refers to “continued strength in the labour market data and moderating GDP growth sending different signals”, it would appear that the labour market data has a higher weighting from a policy perspective.

We are somewhat perplexed by that approach, given that employment is seen to be a lagging variable, and while the lags may be longer in this cycle, we think it is reasonable that the slowdown in expenditure and income growth will eventually weigh on jobs growth. The minutes even refer to the evidence around forward looking indicators of labour demand being mixed with job advertisements having eased but job vacancies having increased as a share of the labour force. What is unclear is whether businesses, in a climate of softening demand, actually intend filling these vacancies.

We were interested that the Governor excluded his standard growth forecast for the current year in his Statement immediately following the April Board meeting. The minutes also exclude that forecast while pointing out that the 2018 growth rate of 2.3% was “below the forecasts presented in the February Statement on Monetary Policy”. It appears almost certain that the RBA will lower its growth forecast for 2019 from 3 per cent (above-trend) to 2 ¾ per cent (around trend). Of course, the RBA has consistently argued that growth in 2020 will be a ¼ per cent below 2019 due to a slowdown in the contribution to growth from LNG exports. If it is to be true to that approach then it will have to forecast growth in 2020 at 2 ½ per cent (below trend). Traditionally, central banks which are forecasting below trend growth should at the least be adopting an easing bias. The tension between growth and the labour market data may allow a looser interpretation of the policy stance. Certainly, the approach taken in these minutes appears to point to a bias towards lower rather than higher rates, although ongoing strength in the labour market will keep rates on hold, at least for the time being.

Further support for this ‘bias’ interpretation comes with the observation that “financial market pricing implied that the cash rate was expected to be lowered in the second half of 2019 and then again in 2020”.

While in previous commentaries, the RBA was dismissive of a significant wealth effect, or a near-term downturn in dwelling construction, these minutes are more realistic. Weakness in consumption, is noted to be concentrated in those items that are historically most correlated with housing prices and housing turnover, and the RBA’s liaison suggested that growth in housing related consumption had remained soft in recent months. Dwelling investment is noted to be past its peak but there is still uncertainty about how quickly dwelling investment might decline with a large amount of work still in the pipeline. Westpac expects a contraction in new dwelling investment of around 10% in 2019.

Conditions in the established housing market are noted to have remained weak in recent months, with house prices continuing to fall in Sydney, Melbourne and Perth, and even declining in most other capital cities and regional areas. The RBA offers no forward guidance as to how far this cycle has to run. Westpac expects that this market will remain soft throughout the course of 2019 and well into 2020.

Conclusion

We have been encouraged by these minutes from the perspective of our rate cut call.

The Board has made a clear case for the benefits of lower interest rates, discounting arguments to suggest that it sees little benefit from lowering rates given the very low starting point. The Board also lays out clearly the conditions for lowering those rates around inflation and the labour market. It appears that it has resolved the uncertainty around the conflicting signals between growth and employment by favouring the labour market. That is disappointing for us, given that the previous policy responses have been linked to growth forecasts, although we expect that persistently slow growth should begin weigh on the labour market.

While prospects for a policy response in May have disappeared, there is still ample time and data releases to justify our timing that there will be cash rate cuts in August and November.

Spot on except the cuts are coming earlier. Capital Economics is now predicting three cuts by early next year. I see four before 2020 is done.

Hello ZIRP.

Comments

  1. I’ve been telling my clients since February we’d see three 25bp cuts this year. June – post election – August and November.

    The amazing thing about the Minutes is that the RBA, an inflation targeting central banks, doesn’t seem to ever tak about inflation. Not mentioned once in the domestic economic conditions section and barely mentioned in the policy section, it’s as though inflation is really something from mars or something… weird

    • Good call.

      I also noticed the RBA says this: “a lower level of interest rates could still be expected to support the economy through a depreciation of the exchange rate”.

      But am I right in thinking at least one rate cut this year is already priced in? So now if they want to drop the currency they need to cut 50bps at once, or cut more times.

      • proofreadersMEMBER

        Time for depositors to reach for the razor blade for the last time, as the kamikaze squad from the RBA is about to embark on its final mission?

      • When you are building up your cache of physical cash, try to get as many new $ 50 dollar notes as you can…….first in best dressed.

    • ChristopherJMEMBER

      Good points, Peter. A June cut, perhaps too soon for a corporate focused board so soon after an election, but they’ve set it up so that most of us won’t connect the dots to their treachery, so you could be right. Me? August. The MSM will cheer on, as will punters, even tho we’ll only get 10 of the 25 bp cut.
      A progressive, independent bank would be thinking about at 75 bp cut.
      We are not sovereign. Whoever first penned that, I agree.

      • proofreadersMEMBER

        Like every other central bank you can think of, our central bank has f.cked up and expects savers to pay for it?

  2. The RBA minutes clearly indicate that they are willing to cut the cash rate and have set out the conditions that need to be fulfilled for it to occur. We are encouraged by this new detail, and continue to believe the RBA will cut the cash rate in August and November this year.

    We? Not I, not encourage at all.. No more lower teh rates!

    • Gav much as I would like to agree, they have now spied the big lever and it’s only a question of how hard they pull it and when.

      I just hope they do it in a way that drops the AUD properly (good for the economy, good for USD holders!).

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