Bill Evans: RBA overconfident of rebound

Via Bill Evans at Westpac:

As expected, the Reserve Bank Board decided to leave the cash rate unchanged at 0.75%.

The key themes around the policy outlook which have been consistently promoted in these RBA statements in recent months have been repeated today.

Firstly, the Board “continues to monitor developments, including in the labour market”, and secondly, “the Board is prepared to ease monetary policy further if needed”.

However, an additional theme appears in today’s Decision Statement, “long and variable lags in the transmission of monetary policy”. This is not a new observation, given that it has appeared in Board minutes in the past but being elevated to the more succinct Decision Statement gives it some enhanced prominence.

The recent surge in established house prices, particularly in Sydney and Melbourne, has attracted further interest. The Governor now notes that the lower cash rate “has also boosted asset prices, which in time should lead to increased spending, including on residential construction”. The relevance of house prices per se, and their impact on the real economy, will be a major source of policy discussion in the first half of 2020. The only other significant change to the Decision Statement in November is a more balanced outlook for the global economy – “while the risks are still tilted to the downside, some of these risks have lessened recently”.

Other consistent themes are: “economy appears to have reached a gentle turning point”, “the main domestic uncertainty continues to be the outlook for consumption”, and “the unemployment rate… is expected to remain around this level [5¼ per cent] for some time”. However, in a direct reference to the need for further policy stimulus, the theme that “the Australian economy can sustain lower rates of unemployment and underemployment” stands out.

Finally, in reference to the turnaround in established housing markets, the Decision Statement still notes that “new dwelling activity is still declining and growth in housing credit remains low”.

Conclusion

This Decision Statement is a little more positive than we have seen in the past, mainly through the linking of rising house prices to a potential lift in spending and residential construction. It also continues to emphasise that the Board is prepared to be patient, is monitoring developments, that policy has long and variable lags, and is prepared to ease  “if necessary”.

If we were expecting a policy move over the next month, then this Decision Statement would raise some questions. However, our forecast that there will be a cut at the February meeting looks much safer. Over the course of the next few months, there will be a clear test of the RBA’s view that the unemployment rate will hold steady. There will also be further evidence around the strength of the consumer with the national accounts to be released tomorrow as well as two more retail sales reports.

The response of the Australian dollar to any confidence that the RBA will be on hold in February will also be important. We assess that one of the factors behind the consistently low AUD is the expectation that the RBA will continue down its easing path.

Overall, despite this emphasis on “monitoring” and the slightly more upbeat discussion on the Australian economy, we still feel confident that the rate cut in February will be delivered.

Furthermore, we argue that the growth, the unemployment rate, and inflation developments through 2020 will require further attention from the RBA culminating in a final rate cut to 0.25% in June. From that point, with further easing still required, the RBA will need to move to a form of Quantitative Easing, based on the regular monthly purchase of around AUD 2-3 billion of government securities.

Oh Magoo, the RBA has done it again. Bond yields have been hosed and the AUD jumped. How much has the RBA’s proven overconfidence cost Australia over the past decade?

A lot.

Houses and Holes

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.

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