Via Bill Evans at Westpac:
The RBA Board meets next week on July 2. Westpac expects the cash rate to be cut by 25bps to 1.00%. Beyond July we continue to expect a further 25bp cut with November the most likely window for a final move taking the rate to 0.75%.
As noted previously, we have brought forward the timing of the next move slightly, from August to July. Our original timing was based on past easing cycles and the notion that a pause between cuts would allow for a smoother transmission process and clearer guidance through the RBA’s Statement on Monetary Policy (SMP). However, the explicit signals provided in the Governor’s most recent commentary have changed our assessment. These include: that it would “… be unrealistic to expect that lowering interest rates by ¼ of a percentage point will materially shift the path we look to be on”; that “the possibility of lower rates remains on the table”; and that it “is not unrealistic to expect a further reduction in the cash rate”.
These are early days for interpreting this Governor’s language at a time when policy is active. However based on our experience with other central bankers, this language is unusually direct. It is about as far as the Governor can go with forward guidance given that he cannot pre-commit to a decision that is decided by the RBA Board as a whole. As such, we now expect a cut in July that will substitute for the move we had originally expected for August.
This will complete the two cuts we originally forecast on February 21 when markets were priced for only one cut by March 2020. The timing however is somewhat earlier than we anticipated back in February.
Importantly the RBA Governor has made it clear that the case for easing stems from a reassessment of labour market dynamics – specifically that the unemployment rate will need to be closer to 4.5% than 5% to generate a lift in wages growth. This means that while the monthly data flow, assessments of the balance of risks and the Bank’s forecast review cycle remain important, they are not the driving force behind current moves. With the unemployment rate at 5.2%, the Bank’s forecasts envisaging little improvement over the next two years and the Governor on the record as saying the June move alone is unlikely to shift that path, the case for a July cut already looks to have been made.
RBA communication around the July decision will be of close interest. The Governor’s statement accompanying the decision in June offered relatively little, leaving open the prospect of further action but without the more explicit rhetoric deployed in the Governor’s recent speeches. The Bank may take the same approach in July, noting that the Governor is again scheduled to speak in the evening following the Board meeting, as he was in June. However we suspect the wording in the decision statement will need to be re-crafted if the Board anticipates a different tempo and conditionality around future moves.
Beyond July we expect the RBA’s forecasts to become more of a focus. We had thought it was reasonable to expect the Bank to lower its growth and inflation forecasts in the August SMP, a move that would be part of a decision to cut in the same month. However it now appears, again based on the Governor’s latest commentary, that the Bank may instead decide to leave these largely unchanged. In particular, Governor Lowe stressed in his most recent speech that the decision to cut in June “was not in response to a deterioration in the economic outlook since the previous update was published in early May”, following this up in Q&A with the comment that “we’re not cutting rates because the economy’s getting worse. We’ve cut rates, and we’ll probably cut them again, because we want the economy to be better.”
These comments are particularly noteworthy as they come after the March quarter national accounts released the day following the June Board meeting. The implication is that the Bank’s outlook has not changed despite what was a disappointing set of figures (output growth weakening to 1.8%yr, the slowest pace since the GFC, and private demand contracting).
On paper, it still looks a bit of a stretch for the RBA to retain its May forecasts for growth of 2¾% in 2019 and 2020 and underlying inflation of 1¾% in 2019 and 2% in 2020. While the policy parameters will have shifted by August (the update is likely to include a note something along the lines of “having already cut rates twice), the shift is not great given the May forecasts were already conditioned on market pricing at the time which included two rate cuts by the end of 2019. Current market pricing now has a third rate cut by year end, so, assuming that is the case through to August, the ‘benefit’ from improved policy parameters is only likely to be 25bps. Around key currency and commodity price assumptions there has been even less change compared to May.
Against this, the Federal election result has generated some positives, particularly around business confidence and the housing market, where the threat of tax policy changes under a change of government has clearly been a factor weighing on investor activity.
Regular readers will recall that on May 24 Westpac forecast a terminal rate in November of 0.75%. This was ahead of all major forecasters and market pricing. Although the Bank may decide to hold its growth and inflation forecasts steady in the August SMP we do not expect it to be possible to sustain this view through to November.
Westpac expects growth of 2.2% in 2019 lifting to 2.5% in 2020 and underlying inflation of 1.4%. Official forecasts more in line with those estimates are likely by November. That in turn means it will not be possible to credibly lower the Bank’s unemployment rate forecast, which currently stands at 5% by end 2020, still well above the 4.5% level now assessed as full employment. That combination means a further rate cut would be appropriate.
When we released the May 24 forecast we noted that the risk to the rate view was to the downside with a potential terminal rate of 0.5% possible. We remain comfortable with the 0.75% target but recognise that given the current official intense focus on lowering the unemployment rate these downside risks have increased.
The focus on the unemployment rate also raises prospects of the timing of rate cut decisions continuing to be less predictable. In previous cycles growth and inflation and changes to associated forecasts have dominated the timing of decisions with rate cuts tending to come at the February, May, August and November meetings that follow CPI updates and coincide with revised forecasts published in the Bank’s SMP.
As we expect to see in July, that timing ‘convention’ has changed because of the focus on the labour market. The SMP publication cycle is less suitable with updates on jobs and unemployment released monthly and updates on wage inflation usually released in the weeks just following SMP updates. With global developments also in the mix – we expect the FOMC to cut rates by 50bps in 2019 – it is possible that our November target date for the next rate cut after July is more flexible than in previous easing cycles.
I agree they’ll cut again next week.
