Australia | Nov 05 2008
By Andrew Nelson
The Reserve Bank of Australia (RBA) has again exceeded market expectations, cutting official interest rates by 75bp (to 5.25%) at its November meeting after a full 1% cut last month. One of the main points of consensus between Australia’s stockbrokers is that it looks like the central bank has shifted its core concern from inflation to economic stability.
Historically, this means the RBA has, in just over two months, undone what took more than four years to put in place. The only period of easing that comes close to this since policy actions have been announced in Australia was the first half of 1990, when rates were cut from 18.00% to 15%. That move, much like the latest, was aimed at reducing the prospect of a deep and prolonged recession. Deutsche Bank notes that one result was a significant target undershoot by inflation.
Almost as one, brokers are predicting another cut of 0.5% next month to 4.75% before the easing stance is expected to soften somewhat. By June 2009 most are now expecting the rate to settle at around 4%, with significant risk remaining to the downside. Although, Deutsche Bank warns that it seems like the RBA is playing a bit of a psychological game in making surprise cuts to help hold off the prospect of the recession. So once the market sets an expectation, the broker reasons, “surely the Bank will not deliver because it is no longer a surprise”.
The broker is expecting a rate of 4.5% by June, but admits there is a big risk to the downside and thinks 4.5% may well be reached much sooner than expected. Macquarie and GSJB Were are both picking 4.25% by the end of March, which is also the lowest rate reached during the previous easing cycle in December 2001, the latter notes. Merrill Lynch hasn’t set a target, but expects at least 4.5% early next year, while UBS expects 4.75% by the new year, but stops short on making further predictions, saying further cuts will depend at least partly on signs of easing inflation pressures.
ABN Amro is the most aggressive in its outlook, predicting that we’ll see a 4.5% cash rate by the end of this year, falling to 3.75% next year. (We noticed economists at Standard Chartered share a similar view).
All in all, these brokers seem to agree the RBA is taking a pre-emptive approach in easing monetary policy in larger than expected chunks as indicators of global and Australian economic activity continue to weaken. In fact, the RBA expressed concerns that not only have the economic data indicated very weak growth in the developed world, it noted there are also further signs that China is weakening considerably. Merrill Lynch adds that the central bank will also be concerned about an unwinding of much of the gains that have been made in the terms of trade over the past six years.
At the same time, the central bank has downplayed its recent concerns about inflation, saying the now much weaker currency, lower borrowing rates and the government’s fiscal stimulus package should provide some offset to weaker growth. ABN Amro points out that this direction represents a shift from the Deputy Governor’s comment last week that “there is still a big task ahead to bring inflation down and this could limit room for manoeuvre on monetary policy”.
Despite the rhetoric about decreasing inflation risks, Macquarie notes that the fall in the AUD could mean, in the RBA’s words, ”that the decline of inflation to the target could take longer than would otherwise be the case”. The broker doesn’t see this as being compelling enough in itself for the RBA to see this as a major concern.
UBS agrees, noting the RBA’s mention of the weaker AUD as causing slowing the fall in inflation, but also points out the bank thinks this will not lead inflation higher. Although, the broker does note it sees the RBA as being more cautious about the FX benefits, which will not fully offset the effects of deteriorating international conditions and falling commodity prices.
Macquarie notes the RBA’s actions to date support its call for quickly reducing rates, as they indicate the bank is willing to do what it takes to hold off the possibility of a recession, so the broker expects nothing other than the bank to continue to cut rates aggressively to achieve a monetary policy that is accommodative to the broader economy as soon as possible.
UBS agrees again, thinking the RBA will be much more interested in getting monetary policy back to neutral as its first and most urgent priority, regardless of current inflation reads. The broker thinks a neutral rate will be around 5%, but any reduction in cash rates after that point will be dependent, at least partly, on signs of easing inflation pressures and some better quarterly inflation prints. But that’s fine, thinks the broker, as it already sees inflation easing faster than generally expected in 2009.
GSJB Were is also in-line, saying that the commentary accompanying the decision appears to attribute the aggressive cutting bias to the outlook for domestic activity as the positive boost to income from higher commodity prices unwinds. The broker also thinks Monday’s weaker-than-expected economic data also had a material influence on the decision. The broker thinks the cuts when coupled with a boost to fiscal policy and the weaker currency will position the economy for a solid recovery over 2H09. But Were’s warns, it may come a bit too late to avert a mild recession over 2H08. ABN Amro is supportive of this view, saying it has already noted there is a good chance that GDP in Australia is already contracting.
Merrill Lynch sees the current outlook for domestic activity as being balanced between the support coming from easier monetary policy, increased fiscal spending and the depreciation of the AUD, which are fighting against headwinds coming from weak external demand, falling commodity prices, poor sentiment and corporate balance sheet deterioration.
The flow of economic data today has made the task of picking the RBA’s future course even more difficult, with the Australian Federal Government saying it is now expecting a Budget surplus of $5.4bn in 2008/09, down from the original estimate of $20.7bn. While much of the downgrade is due to the recently announced fiscal package worth just over $10bn, weaker economic conditions have also taken a bite.
ANZ Senior Economist Katie Dean thinks that this revision may even be too light, given they are based on what Dean describes as overly optimistic economic forecasts. She notes the government is forecasting for real GDP to come in at 2%, down from 2.75% for 2008-09 and the first cut of forecasts for 2009-10 point to only a modest pickup in growth to 2.25% next year. However, these numbers sit above the RBA’s numbers and at the hopeful end of forecasts, she notes.
Dean also thinks that the government’s prediction of a 5.75% unemployment rate by mid-2010 is a best-case scenario given the very sharp deterioration in the recent leading indicators for employment. Look at the last ANZ job ads read. She also doubts the government’s ability to maintain its current budget surplus and that any further loss of growth momentum or any further announcements of fiscal stimulus will result in the budget moving into deficit.
This isn’t as big of a deal, says Dean, as keeping the budget in surplus in times of economic weakness isn’t the right priority, so it would be entirely appropriate for the Government to enter into deficit in order to support spending and confidence in the economy.
Trade balance and building approval data also support recent government intervention and the RBA’s move to a more stimulatory stance, with Dean noting that a better than expected trade surplus was aided to an unprecedented level by the falling AUD. A sharp fall in September building approvals, however, proves that if not for the $10.4bn fiscal package hitting households in the month of December, we would almost certainly be looking at negative economic growth in the December quarter.