Australia | May 08 2013
– RBA saw need to support economy
– Economists predict more cuts will be required
– Westpac and Macquarie see a 2% cash rate ahead
By Greg Peel
Is the Reserve Bank of Australia “behind the curve”?
In its April monetary policy statement, the RBA suggested “Global growth is forecast to be a little below average for a time, but the downside risks appear to be reduced”, and for Australia, growth is “likely to be a little below trend over the coming year”.
In its May statement, the RBA suggested “The global economy is likely to record growth a little below trend this year, before picking up next year, and “Growth in Australia was close to trend overall in 2012, but was a bit below trend in the second half of the year, and this appears to have continued into 2013”.
A comparison would suggest the RBA has very moderately downgraded its global and Australian economic growth expectations from one month to the next. More subtlety, China’s growth in April had “stabilised at a fairly robust pace” but in May was “running at a more sustainable, but still robust pace”.
In essence, the above allowed the central bank to use “some” of the “scope” provided by a benign inflation outlook to cut its cash rate by 25 basis points to 2.75% yesterday. It was a move “necessary to support demand” in the Australian economy, with a stubbornly strong currency now deemed to be “unusual”.
Ahead of yesterday’s announcement, some 70% of economists were assuming the RBA would hold off until June. The Macquarie economists were not in that number, believing that the benign inflation outlook did not simply “provide scope”, but suggested the RBA “would need a good reason not to cut rates”.
Macquarie has just completed its 15th Annual Macquarie Australia Conference, at which 100 Australian listed companies, covering industrials, resources, financials, listed property trusts and emerging leaders, presented. The universal theme, the hosts report, was one of increasing productivity through cost management in order to drive better profitability. Macquarie believes this theme represents “clear recognition” across the spectrum that business conditions are weak and will remain weaker than in past cycles, and suggests yesterday the RBA acted on its own recognition of this reality.
The media has since had a field day, with the Fairfax mastheads running front page pictures of Elvis Presley and Robert Menzies to highlight the fact the cash rate has not been as low as 2.75% since the fifties. Happy days. Also highlighted has been the fact that 2.75% is lower than the 3.00% trough rate in 2009 at a time of Global Financial Crisis.
To focus on the actual rate is to nevertheless overlook two important considerations. First is the interest rate differential between Australia’s rate and that of other major global economies, which has widened on the back of low interest rate policies and rampant money printing in most centres (which in effect imply negative cash rates). The 3% rate in 2009 represented a narrower differential than in 2013. Second is the RBA’s observation in its May statement that “interest rates have already been reduced substantially, with borrowing rates approaching previous lows”. In other words, while the cash rate is now lower than it was in 2009, mortgage rates, for example, are not. The lowest standard variable rate was 5.75% in 2009, while ahead of yesterday’s cut it was 6.45% (albeit banks have been offering discounts).
The difference in SVRs reflects the fact that in 2009 Australia’s banks were desperate to restock their loan books with primary quality “bricks and mortar” loans to replace distressed business loans, while in 2013 the banks, and particularly the bigger two, have quite a full supply of mortgages.
On this comparison, the RBA still has further “scope” before we really can deem borrowing rates to be lower than those prompted by the GFC.
Commonwealth Bank suggests the lack of emphatic change in the RBA’s global and domestic economic outlooks from April to May, as highlighted in my “subtle” comparisons above, could just as well have justified no rate cut yesterday. The central bank has nevertheless drawn on the lower than expected March quarter CPI numbers to “take the opportunity to speed up the baton pass” from the peaking mining sector to the struggling non-mining sector.
CBA forecasts that the RBA’s further “scope” implies one more cut this year, which the economists believe will come in August, to 2.5%.
The ANZ Bank economists also found it “unusual” that the RBA statement accompanying this rate cut was not as “dovish” as rate cut statements would normally be. On that basis, ANZ believes the cut was largely a “judgement call” that the economy could do with a bit of extra support right now.
Like CBA, ANZ is forecasting one more cut this year, in either August or September. But given a weak outlook for non-mining investment in the second half of 2014 and into 2015, the economists believe there remains a risk rates could be lower than their 2.5% forecast over the next 12-18 months.
Macquarie believes the next rate cut will come as early as next month. As noted above, Macquarie was backing a May cut, reflecting mining companies laying off workers and shelving investment projects, building companies indicating no pick-up in activity, and the additional tax levy announced by the government to fund the National Disability Insurance Scheme. The central bank rarely delivers just the one cut in isolation, Macquarie points out, thus June is a very strong candidate given the raft of March quarter data which the RBA will then have at hand, ahead of the GDP release.
As late as this May statement, the RBA is holding onto its belief that the peak in resource sector investment is “likely to occur this year”. Macquarie expects the March quarter capital expenditure data to confirm that mining investment has already peaked.
Macquarie believes mortgage rates need to be lower now than they were in the GFC cycle trough “to get the same traction on the economy”. The argument is even more compelling when we consider the stubbornly high Aussie and fiscal policy working against monetary policy. Indeed, Macquarie believes the cash rate will be 2.00% by the end of 2013.
Macquarie points out that often one rate cut is followed by another a month later. Westpac confirms that over the last ten years the RBA has made four rate changes in May, and on two occasions followed up with another change in June. Westpac also believes the RBA will cut again in June, because “it will become clear that business investment intentions are soft, both business and consumer confidence are fragile and credit growth continues to remain subdued”.
The Westpac economists were somewhat chuffed yesterday because one year ago they had forecast a low point of 2.75% in the easing cycle when all about them were forecasting 3.25-3.50%. A year later, that low point forecast has been reduced. Westpac notes the IMF is expecting global economic growth of 4% in 2014. Westpac is forecasting 3%. The RBA suggests Australian growth will be “a bit below trend”. Westpac is forecasting growth “stuck at a below trend 2.5% in both 2013 and 2014”.
Westpac believes yesterday’s cut was “very significant” because it indicates the RBA sees a “new urgency” to use interest rates to support demand. Like Macquarie, Westpac believes next month’s March quarter capex data will be critical, and likely imply that confidence and credit growth are not indicating much evidence to support an improving investment environment.
Westpac believes the RBA will cut again in June then wait to assess the impact, before cutting again once in the December quarter and again in the March quarter next year. The economists believe the subsequent 2.00% cash rate will remain in place for the rest of 2014.
Is the RBA “behind the curve”? Economists will tell you central banks have a history of always being behind the curve, and on the strength of the arguments above, this time is little different. The last word can go to the Credit Suisse quantitative stock market analysts who last week noted:
“Value factors work when deleveraging pressure is not material. However, with the Australian real yield curve recently inverting, the bond market is suggesting that the RBA is falling behind the curve again, risking more deleveraging”.
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