Bill Evans: RBA to hold next week

Via Bill Evans of Westpac:

The Reserve Bank Board meets on August 6 to consider whether to extend the sequence of rate cuts in June and July for another month.

We think it is quite unlikely that the Board will decide to do a third consecutive cut at this meeting.

Following the cut in July, the Governor noted, “The Board will continue to monitor developments in the labour market closely and adjust monetary policy if needed to support sustainable growth in the economy and the achievement of the inflation target over time”.

That statement compared with the June statement, “The Board will continue to monitor developments in the labour market closely and adjust monetary policy to support sustainable growth in the economy and the achievement of the inflation target over time”.

The inclusion of the term “if needed” in the July statement indicates that the level of urgency for the next cut is lower in July than it was in June – implying that some time would be required to assess whether another cut was needed.

I wrote at the time of the release of the July Board minutes: “my experience is that when a central bank decides to pause, it often refers back to previous policy decisions. In the final paragraph of the July minutes, the Board notes “this decision, together with the reduction in the cash rate decided at the previous meeting, would assist in reducing spare capacity in the economy”.

Finally it is worth recalling the final paragraph of the speech which the Governor delivered after the Darwin Board meeting in July when he noted: “So we will be closely monitoring how things evolve over coming months.” The use of the plural (months) seems to be confirmation that there would be no urgency to move as soon as August.

On July 25th, we revised our forecast of the timing of the next rate cut from November to October. In addition we extended the easing cycle to include another, and final, cut, in February next year. We remain comfortable with that view.

The Governor’s Statement next week will be of interest particularly around whether he is planning to move as soon as September. Here we will certainly be interested in whether he persists with the “if needed” qualification. We favour that term still being used implying that, at least at the time of the meeting, the Board expects to hold fire in September.

Other themes will be consistent with the July statement are: strong employment growth but spare capacity in the labour market; housing conditions soft, although tentative signs of stabilisation in Sydney and Melbourne (CoreLogic reported house prices in Sydney and Melbourne lifted by 0.2% in July); inflation pressures subdued, although the central scenario remaining for trimmed mean inflation to be 2% in 2020; and the central scenario remaining for growth to be around trend.

These themes will give us an early signal of the revised forecasts for growth, inflation and unemployment which will be released with the August Statement on Monetary Policy on August 9. These forecasts are critical for gauging the Bank’s approach to policy and he will be testifying to Parliament that same morning.

Recall that when the last set of forecasts was released in May, the RBA forecast GDP growth at 2.75% in both 2019 and 2020. That is a benign outlook given that “trend” is assessed as 2.75%. However it is going to be difficult to credibly maintain the 2019 growth forecast at 2.75%.

Since the May Forecasts were released, GDP growth in the March quarter printed a low 0.4% and the partials for the June quarter are pointing to around 0.5%. A 0.9% read for the first half of the year requires 0.9% quarterly increases in each of the last two quarters.

Now we acknowledge that the second half of 2019 will be stronger than the first half with the benefits of the rate cuts, tax cuts, stabilising of the housing markets in Sydney and Melbourne, and lower AUD; but we certainly do not see growth lifting to an annualised pace outside 2.5-3.0%. It is most likely that the RBA will choose the 3% pace and lower the forecast for GDP growth in 2019 to 2.5% from 2.75%. That would provide a credible base for retaining the 2.75% forecast in 2020. We see the pace at nearer 2.5% in 2019 H2, ultimately pushing the RBA’s forecast for 2019 back to 2.25% and 2020 to around 2.5%.

The June quarter Inflation Report provided the RBA with some welcome news. The trimmed mean inflation rate for the quarter printed 0.42%, above the Westpac forecast of 0.3%. This followed a 0.3% in the March quarter. We detected a stronger than expected pass through in clothing, footwear, household goods and cars from the low AUD.

With 0.3% in Q1 followed by 0.42% in Q2, the RBA can, with a large stretch, retain its forecast for the trimmed mean of 1.75% for 2019, making a drift up to 2% in 2020 a reasonable outcome. We expect the trimmed mean in the September quarter to print 0.3% for a rounded 1.5% for 2019. The RBA is likely to confront that reality for the November Statement, forcing it to delay the return of the trimmed mean inflation rate to 2% in 2021. For now, it will most likely continue to declare that trimmed mean inflation will be back within the 2-3% band in 2020.

So far, so good, but the unemployment rate forecast is likely to be a major problem for the RBA. Recall that in May, it forecast the unemployment rate to hold at 5.0% through 2019 and 2020. Unfortunately the rate for June has lifted to 5.24% against a May SOMP forecast of 5.0%. The problem is compounded by the ‘rule-of-thumb’ amongst economists that above trend growth is required to lower the unemployment rate. At best, the RBA will be forecasting trend growth in 2020, challenging any forecast that the unemployment rate will fall from the current 5.25%.

It will be this tension with the unemployment rate, which we expect to lift to 5.4% by year’s end that will trigger that 0.25% rate cut in October.

This problem will be further complicated for the RBA by market pricing. The forecasts in May already incorporated the two rate cuts in June and July (although markets were envisaging the cuts to come later in the year). The forecasts in August will incorporate a further cut in October (market pricing) and a near full second cut by mid-2020.

If, as we expect, those forecasts will be barely acceptable for growth and inflation and well below the RBA’s “desired” 4.5% for the unemployment rate, then the very least that the RBA can do is to deliver a 25bp October cut and plan to repeat the dose in 2020 H1.

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Damien Klassen

Damien has a wealth of experience across international equities (Schroders), asset allocation (Wilson HTM) and he helped create one of Australia’s largest independent research firms, Aegis Equities. He lectured for over a decade at the Securities Institute, Finsia and Kaplan and spent many of those years as the external Chair for the subject of Industrial Equity Analysis.
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Comments

  1. Coz the AUD is correcting toward fair value, but Bill, it ain’t there yet.

    What are derivatives for, what is their function and how is it that 65 trillion of derivatives can be unwound t 85 billion dollars?

    Is this the hedging insurance that banks use to bulsh!t investors that their bonds are insulated from currency fluctuations? I just reckon that its this simple, the bank’s USD exposure has exploded due to this exchange rate correction.

  2. Inflation / employment / GDP / blah blah. Really?

    Let’s stop the pretence — you guys don’t have any more idea than a monkey flipping a coin.

    Who’s in charge at the Fed? Oh, that’s right a petulant market and Donald Trump’s Twitter account

  3. Jumping jack flash

    They won’t cut because there’s no need. No more external pressures to try and counter.
    Those last two cuts were for creating jobs and bringing back wage and price inflation as much as a farting cat would. It was obviously to counter that announcement from the US – which curiously hadn’t been announced yet… These central bankers will talk, though, it seems.

    Fearless Phil’s bumbling justifications reinforced that they had nothing to do with jobs, wages or inflation. The first cut was apparently made to improve confidence that rate cuts could improve the economy. The second cut had no justification as far as I know, but if there was one, then it was probably just as vapid and general as the justification for the first cut.

    But seriously, how stupid do they think we are? As if cutting the cash rate 0.5% (partially passed on by the banks to their debt slaves) will somehow, magically, do anything else than make debt a teeny, tiny bit cheaper, and as if any economic effects caused by cutting interest rates is somehow, magically, anything more than taking on and spending more debt?

    And in this current environment of total debt saturation I’m sure there’s queues out of the banks’ doors of people seeking more debt to take on.
    And in this current environment of total debt saturation, spending more debt is clearly the responsible solution to the problem of everyone having spent too much debt.

    • The futures market is pricing in a further 0.25% cut by Christmas with 100% certainty. And a further cut in 2020 is currently about a 40% probability. [One of my colleagues was checking this today]

      What was unclear from the Bill Evans piece was to the extent the growth forecasts for the balance of 2019 and CY2020 have baked those in (it reads like they have – “market pricing”). To me, that reads as if the RBA doesn’t cut then the current forecasts of CPI won’t hold and will actually be lower than current views – so more like 2 to sub 2%.