Via the marvelous Bill Evans at Westpac who so many economists have carbon copied this week on an imminent third rate cut that I ran out time to post on it:
This note is to confirm our RBA forecasts which we released on July 24 that the Bank will cut the cash rate by 25 basis points on October 1 and again by 25 basis points on February 4, 2020.
That call updated our previous call on May 24 when we were the only forecaster (Bloomberg Survey on that day) to argue that the cash rate would fall below 1%.
Over the last few weeks, markets had lost confidence in the October view. At the end of last week markets priced an October move with a probability of 26%.
We were feeling decidedly lonely with our October call.
However, over the course of this week markets have moved to a 80% probability of this move.
What changed over the week?
The most important development was the release of the September RBA Board minutes.
From our perspective, we were encouraged by the sentiments in the minutes.
Following the release of the minutes I wrote:
“The minutes of the Reserve Bank Board’s September meeting contain similar themes to the August minutes but indicate that the Board acknowledges that it is getting closer to its next move on policy.
In August, the Board minutes concluded that: “Having eased monetary policy at the previous two meetings, the Board judged it appropriate to assess developments in the global and domestic economies before considering further change to the setting of monetary policy. Members would consider a further easing of monetary policy if the accumulation of additional evidence suggested this was needed to support sustainable growth in the economy and the achievement of the inflation target over time”.
In these minutes there is no reference to previous actions.
Arguably reference to previous actions is a clear sign that the Board is content to observe developments. By not referring to previous actions there is less emphasis on the need to wait.
It is also interesting that the theme that drove the June and July decisions to cut rates, “the Australian economy could sustain lower rates of unemployment and underemployment”, was repeated in these minutes after being absent in the August minutes.
The minutes refer to three “developments that had a bearing on the monetary policy decision”.
• The labour market – strong employment growth was recognised but the unemployment rate had remained steady at 5.2% (recall that the Governor has noted on other occasions that he would like to see the unemployment rate at 4.5%) and that wages growth “had remained low”. Indeed the minutes point out that “the upward trend in wages growth appeared to have stalled”. We are aware that the Governor sees rising wages growth as the key to a sustained lift in spending growth and higher inflation. In addition the minutes noted that “forward-looking indicators
had continued to suggest that employment growth would moderate over the following six months.”
• The housing market – it was noted that there was “a turnaround in established housing markets” but from the perspective of economic activity there was “further weakness in dwelling investment in the near term” and low turnover in the housing market meant that “spending on home furnishings and other housing related items was not expected to contribute to consumption growth in the near term”.
• GDP growth – the Board meeting was held the day before the release of the June quarter national accounts. When the RBA released its forecasts on August 9 it was expecting GDP growth in the June quarter to be 0.8%. In the minutes it referred to an expectation of 0.5% due to the weakness of the partials in the lead up to the release. That forecast proved to be correct but the minutes also noted that “private final demand was expected to be weak”. (In fact it was flat in the June quarter and down 0.4% for the year! – “weak” is probably an overstatement of the state of final demand).
On the international front the overriding theme was that “the escalation of the US–China trade and technology disputes… had intensified the downside risks to the global outlook”.
The outlook for China deteriorated somewhat and the trade disputes were weighing on East Asia generally.
The minutes make a fairly clear case for another rate cut in 2019.
With two meetings now having passed since the last move and, from my perspective, most importantly, the key rate cut theme that “the Australian economy could sustain lower rates of unemployment and underemployment” returning to the narrative, our central view that there is no reason to wait until
November for the next move still seems reasonable.
November is typically favoured by the RBA since it is a time when it can refresh its forecasts. Though we are not expecting any significant changes along the lines of August when the forecast unemployment rate was lifted; the forecast pace of wages growth was lowered; and the timing of the return of inflation to the 2–3% band was pushed out by a year. The growth forecast in 2019 is likely to be lowered but the 2020 forecast should remain intact.
However, as the minutes warn, “developments in the international and domestic economies, including the labour market” will be assessed to see whether a further easing of policy is “needed”.
Westpac continues to predict cuts in the cash rate of 25 basis points in both October and February next year.”
The second development in the week was the decision by the US Federal Reserve’s FOMC to cut the federal funds rate.
While this was a widely expected move it would have emphasised, along with the previous week’s move from the ECB, that global rates are falling.
Further, although there were apparent differences amongst Committee members the Chairman is clearly favouring policies that will maintain the expansion.
My colleague, Elliot Clarke, observed that:
“As Chair Powell (and we assume the Committee) see “high value” in sustaining the expansion, further action on rates is therefore likely in coming months, as growth expectations are revised down.
Indeed, Chair Powell was clear in the press conference that “history teaches us it is better to be pro-active in adjusting policy” and that the “majority of the committee is going meeting by meeting”.
The RBA seems to have a cautious attitude to the global and US outlook and would therefore be factoring in prospects of further rate cuts from the FOMC.
Yesterday we saw the Australian employment report for August. Note that the minutes emphasised the labour market as continuing to be important for the policy outlook.
The August employment report would have been very disappointing for the RBA. As my colleague Justin Smirk observed:
“The August Labour Force Survey reported a 37.4k gain in total employment. Employment remains robust with a three month average of +24.0k in August, +25.9k in July and +31.2k in June.
The unemployment rate rose to 5.3% from 5.2% in July.
However, at two decimal places it would be better to describe it as a flat outcome with a 5.25% print from 5.24%. Still, given the outsized gain in total employment even a flat print on unemployment is somewhat disappointing.
This is where it is important to remember how the final results of the survey are compiled. From a household survey, the ABS derives the various ratios on labour market performance; that is unemployment, participation, employment to population etc, which are then applied to an estimate of working age population to generate the level of employment,
unemployment, underemployment and the labour force.
As such, employment accelerating as population growth picks up is not unusual. In fact it is to be expected as, with all else held equal, a rise in the pace of population growth would see a lift in employment growth even if the employment to population ratio was steady. So with steady estimates of population growth the reported employment gain will also be steady. This is why the recent softness in the labour market is being highlighted by rising unemployment rather than employment growth.
The pace of growth in employment, and the change in participation, are correlated so it is not surprising that participation has lifted as employment remains robust – a strong labour market will bring more workers back into the labour force. But what is surprising this time is that the gains in participation are outpacing those for employment, hence the trend rise in unemployment. This suggests there may be as much pushing (workers looking for more income) as there is pulling (workers attracted back by a robust labour market).
This second is a strong indicator, the first is more questionable and a sign that participation may not fall as much as you would expect should the labour market soften.
There are further signs the labour market may be softer than you think. Back in June we were surprised by the drop in underemployment (those employed who are willing and able to work more hours) which fell 0.4ppts to 8.2%.
Underemployment did not improve as much as unemployment through 2018 and in early 2019 had been trending higher compared to the unemployment rate. So we were not surprised that in July underemployment bumped back up to 8.4% and in August it rose again to 8.6%. Rising underemployment is a further sign that the labour market continues to underperform
and that excess capacity is rising in the economy.”
We think the RBA is now firmly on board with this approach to assessing the labour market – strong jobs growth really reflects rising population and higher participation, whereas the rising unemployment and underemployment rates are the true measures of the state of the labour market and its spare capacity. And of course, rising spare capacity puts downward pressure on wages growth.
A realistic question is whether the follow up cut to the October move could come earlier than February – our forecast.
One of the reasons why we argued consistently for October over the consensus view of November was that, if global conditions deteriorated sharply near year’s end, the RBA would like the flexibility to move again.
We think that the response of the Westpac Consumer Sentiment Index (down 4% in July) precludes another back-to-back move, as occurred in June-July. But going in October leaves available the flexibility to move in December. Waiting until November detracts from that flexibility.
We think the RBA would see the move to 0.5% as the low point in the cycle after which unconventional policies would be required. A prudent wait for that last move until early next year seems the most likely option.
Sounds exactly right to me.
He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.