From Bill Evans of Westpac:
As expected, the Reserve Bank Board decided to leave the cash rate unchanged at 1.00% at today’s Board meeting.
In terms of the signalling of future policy, we were most interested as to whether the final sentence in the Governor’s decision statement would retain the wording “ease monetary policy further if needed”, we saw in the July decision statement. That wording implied that some time would be required to assess the next move. It contrasted with the June decision statement where “if needed” was not used, indicating a preparedness to cut at the next meeting. In August, “if needed” was again used, and accordingly, we remain comfortable with our forecast that the next rate cut will come at the October meeting rather than the September meeting.
The decision statement which precedes the release of the RBA’s revised forecasts on the following Friday can also provide an early indication of those revisions. In this statement, we are given the revisions for growth, underlying inflation and the unemployment rate out to the new forecast horizon of end 2021 (previous horizon ended in June 2021).
For growth, the RBA has revised down its forecast for 2019 from 2 ¾ per cent to 2 ½ per cent — in line with our preview which printed on August 2. That is not surprising given that growth in the first half of 2019 is likely to print around 1 per cent, making the previous forecast of 2 ¾ per cent highly unlikely. However it has retained its forecast for 2020 of 2 ¾ – around trend growth. Westpac still sees those forecasts as too high – favouring 2 ¼ per cent in 2019 and 2 ½ per cent respectively.
For underlying inflation, the previous forecasts were 1 ¾ per cent in 2019, 2 per cent in 2020 and 2 per cent in the year to June 2021. When the June quarter trimmed mean printed 0.4%, following a 0.3% in the March quarter, we revised up our estimate of the where the RBA would forecast 2019 from 1 ½ per cent to 1 ¾ per cent. We argued at the time that such a forecast would be an unrealistic stretch but assumed that the RBA would want to maintain a forecast of 2 per cent in 2020.
Accordingly, we welcome the cautious approach to the new 2020 forecast for underlying inflation, which is now described as “a little under 2 per cent for 2020”. That is likely to imply a forecast of 1 ¾ per cent, indicating recognition that the RBA will miss the 2-3 per cent target band for another year. Somewhat offsetting that discouraging forecast is the forecast for the whole of 2021 of “a little above 2 per cent”. So we have gone from a forecast of 2 per cent in 2020 and 2 per cent in the year to June 2021, to 1 ¾ per cent in 2020 and 2 ¼ per cent in 2021. While the 1 ¾ per cent looks realistic, the jump of ½ of a percentage point to 2 ¼ per cent looks like a stretch.
Previously the unemployment rate was forecast to hold at 5 per cent to December 2020 before falling to 4 ¾ per cent by June 2021. Recall that the starting point for these forecasts is 5.24% for June 2019, posing a challenge to reach 5 per cent when the forecast growth rate is below trend in 2019 and only at-trend in 2020. The new forecasts have the unemployment rate drifting down to 5 per cent “over the next couple of years”. That therefore represents an increase in the unemployment outlook, given that the previous forecasts factored in 4 ¾ per cent by June 2021.
Such a forecast is well above the Governor’s informal “target” of 4.5%.
Consequently, the decision statement signals that the RBA will be forecasting less progress on the inflation and unemployment targets than had been expected in the May Statement on Monetary Policy (SMP)( which assumed two rate cuts by year’s end). And of course, we must bear in mind that these new forecasts are based around market pricing which now includes two 25bp rate cuts having been delivered and the prospect of nearly two further cuts to come. In addition, the May forecasts assumed an AUD of USD 0.70 , compared to current pricing of USD 0.68.
So the RBA finds itself in a position where even if market pricing for further cuts proves to be accurate, it still expects that it will have to wait another year until underlying inflation returns to the 2-3 per cent target band and the unemployment rate drops back to its level of a few months ago.
Little wonder that the Governor notes “it is reasonable to expect that an extended period of low interest rates will be required in Australia to make progress on reducing unemployment and achieve more assured progress towards the inflation target”. This guidance for low rates for an extended period comes as a new policy tool.
The commentary around the housing market is somewhat more positive with the Sydney and Melbourne markets being described as “some signs of a turnaround” compared to the July description of “tentative signs that prices are now stabilising”.
Some themes around the labour market are consistent with July with employment growth being described as strong, but little inroads being made into reducing spare capacity. One significant change is a less confident note around wages. In July, the commentary was “a further gradual lift in wages growth is still expected”, whereas in today’s statement, “a further gradual lift in wages growth would be a welcome development”.
Given the developments in the global economy, particularly over the last few days, we are surprised that the RBA is still only talking about the risks being only “tilted to the downside”. We will expect that a more detailed analysis of these risks will be available in the August SMP, which will print on August 9.
We are very comfortable with our view that the RBA has more work to do. Its revised forecasts paint an increasing challenge around both inflation and unemployment. There is also recognition that growth will be below trend in 2019 and is unlikely to exceed trend in the forecast period.
It still remains possible, that the RBA will choose September as the next date for a rate cut, but given that they must see limited future flexibility, we expect that they will be a little patient by moving next in October, and laying the foundation for another move in February next year , when additional unconventional policies might be used to sharpen the effectiveness of the rate cut.
The risk has to be of two cuts sooner than that.