Bill Evans: Next RBA cut in February

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Via Bill Evans of Westpac:

The Reserve Bank Board meets on November 5 next week.

There is little chance that the Board will decide to cut the cash rate at that meeting.

Westpac confirms its forecast which was “refreshed” on July 24 that the Board would cut the rate by 25 basis points at the October meeting (done) and the February meeting in 2020.

Markets are pricing in a probability of a miniscule 4% for a November move.

However it was not always like that.

Back on October 4 I wrote, “we cannot concur with the markets pricing in a 50% probability of a follow up move in November.

There are a number of reasons for this caution.

Firstly, markets should understand that central banks will usually bias their comments on days on which they make policy changes to justify the decision. We saw some examples of that approach in the Governor’s Statement.

For example, he has, for no reason that is justified by the data, adopted a bolder objective than had been the case before by aiming for “full employment” rather than the more modest, “reduce unemployment” that we saw in September.

With the unemployment rate trending away from his full employment target and, by his own admission, “forward-looking indicators of labour demand indicate that employment growth is likely to slow from its recent fast rate” the introduction of that full employment target as a substitute for the more realistic “reduce unemployment” seems curious and is probably less significant than markets may have assessed.

We also think the RBA will be mindful of the response of the Westpac Melbourne Institute Consumer Sentiment Index to the consecutive cuts in June/July. Following the cut in July the Index fell by 4.1%. There was an apparent “spooking” of the consumer around the policy action.

With the RBA seeing the consumer as the key to the growth outlook, a “back to back” series of rate cuts leaving limited scope to cut further and risking a similar response from the consumer would counsel against that November move.”

Since that note we saw the Westpac MI Consumer Sentiment Index fall by 5.5% in response to the October rate cut, providing further evidence of the fragility of Confidence to low rates.

Under such circumstances consecutive rate cuts would seem to be a significant policy mistake.

Apart from the arguments I put forward on October 4 we have also seen an absence of downside surprises in both the Employment and Inflation reports with both the unemployment rate falling modestly from 5.3% to 5.2% and the trimmed mean annual inflation rate holding steady at 1.6%.

Looking further out, markets have turned against prospects for a December rate cut with probabilities falling from 80% back on October 4 to 25%.

We concur with that assessment but are surprised that market pricing for February has tumbled from 100% on October 4 to 50% today.

That latter move seems like an overreaction by markets given that the RBA still retains a strong easing bias. We confirm our forecast for a 0.25% cut in the overnight cash rate at the February Board meeting.

To emphasise the importance of the Employment Report in this cycle it is interesting to note that now that November can be discounted all three moves in this cycle so far in 2019 have been away from the February/May/August/ November cycle which follows the Inflation Report and coincides with the RBA releasing it’s revised forecasts.

Note that since this easing cycle began in November 2011 eight of the cuts before 2019 occurred in those four months whereas only four occurred in the remaining seven months, (no meeting in January).

The second important “event” will be the release of the November Statement on Monetary Policy on November 8.

In this Statement the RBA will “refresh” its forecasts particularly for growth and inflation.

In August the RBA forecast GDP growth in 2020 at 2.8% (around the accepted measure of trend of 2.75%). On a number of occasions the Governor has repeated his confidence in the economy returning to trend growth in 2020 so it seems likely that the RBA will retain that growth forecast for 2020 in the November update.

We find that forecast hard to justify with our forecast currently standing at 2.4%. We are more cautious on consumer spending; expect the drag from the residential construction down turn to be considerably sharper; and question the strength of the lift in business investment that was forecast in August.

We also expect that the downward revisions we saw in August around wages growth (2.3% from 2.5% in May) will be retained , while the lift in the end 2020 unemployment rate forecast we saw in August from 5% (in May) to 5.2% is likely to be retained.

In August the RBA surprised by lowering the forecast for the trimmed mean inflation measure for 2020 from 2.0% to 1.9% – acceptance that it would be yet another year until underlying inflation was back into the 2–3% band was significant.

Since August the Trimmed Mean printed 0.38% for the September quarter keeping annual growth at 1.6%. To achieve the 1.6% rate for 2019, which was forecast in August, the December quarter trimmed mean will need to print 0.5%, our current forecast. Consequently with the starting point unchanged and growth/ wages unchanged in 2020 it seems likely that the RBA will retain its forecast of 1.9% growth for the trimmed mean in 2020.

Finally, we need to assess whether the underlying assumptions might move the forecasts. Recall that the RBA’s forecasts are based on market pricing for interest rates. In August the market was pricing a 65 basis point fall in the terminal rate . Today with one 25 basis point cut having been delivered the market is pricing in a further 25 basis point cut to the terminal rate. So, a total of 50 basis points in cuts compared to 65 in August – an insufficient difference to “move the dial”.

In summary, we expect that the “refreshed” forecasts in the November SOMP will be closely in line with the forecasts in August.

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. 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.