Economics | Nov 04 2015
-Surprise at RBA's relative optimism
-Forecasts for cuts pushed into 2016
-May hinge on Fed and AUD performance
By Eva Brocklehurst
Inflation concerns, or rather a lack of inflation, were seemingly downplayed in the Reserve Bank of Australia's latest statement accompanying its decision to maintain the cash rate at 2.0%.
Growth is flagging and financial conditions have tightened so some brokers were surprised at the lack of action on the part of the central bank this month. The central bank acknowledged Asian trading partner growth had softened and that domestic growth has been below its long-run average for some time.
Morgan Stanley, which construed the September quarter CPI figures as confirmation that demand was weak, acknowledges it was in the minority calling for a rate reduction this month but was surprised by the optimism reflected in the RBA governor's statement.
The central bank's judgement that there are signs of an improvement in economic conditions makes it more dependent on upcoming data, but also leaves its options open, the broker asserts, and the decision increases pressure on the commonwealth government to do more with fiscal policy. On this theme, clarity is sought regarding any stimulus proposals from the government's mid year economic and fiscal outlook (MYEFO), due before year end.
The broker senses the RBA is reluctant to act ahead of any federal mini budget or the US Federal Reserve's meeting on December 17. As a result, Morgan Stanley pushes its forecast for a reduction in the cash rate out to the first quarter of 2016 and retains expectations for a second reduction in the June quarter, to help engineer a soft landing in the housing market.
Macquarie also envisages scope to ease rates and concludes the RBA has a somewhat optimistic outlook. In fact, a delay to any rate reductions suggests a risk the central bank will have to do more next year. The broker's expectation for a rate cut this month was based on a belief the RBA would downgrade its growth and inflation outlook and would have a clear case to offset the increases in borrowing costs from major lenders.
Moreover, the weak CPI and risks of further deflation provide the rationale, given Macquarie observes other major central banks with strengthening economic activity and clear upward inflation trends in their jurisdictions are considering the case for further easing.
Macquarie remain of the view that easing is still likely as the economy has a difficult transition to make, not just with the downswing in mining investment and the hit from lower commodity prices but also because of the closing of the automotive assembly sector from late 2016. The broker also believes the surge in residential dwelling supply at a time of slowing population growth and a tightening in lending practices presents another challenge.
So, what will it take to make the RBA act? Macquarie suspects this could hinge on deterioration in confidence, meaning non-mining capital expenditure is delayed, or a delay in hiking rates by the US Fed, which could push the Australian dollar higher. The upcoming quarterly Statement on Monetary Policy from the RBA and a speech by the governor could shape expectations further over the next week or so, the broker suggests.
Macquarie expects the next move will be a 25 basis point reduction to official rates in February. As a corollary, until the Australian dollar falls to the US60-65c range and remains there for an extended period, Macquarie believes the risk of further policy support from both fiscal and monetary authorities is high.
UBS is a little more upbeat, believing the Australian economy is transitioning better than widely appreciated and may not need further monetary stimulus. In terms of what was new in the RBA commentary, UBS notes the central bank appears more confident in a European recovery and comfortable with the increase in mortgage rates by the major banks. The broker hastens to add that this does not mean the economy needs an increase in the cash rate.
Moreover, renewed easing of rates globally has the potential to push the Australian dollar higher and the case for the RBA lending a hand to support demand may still arise over the next few months. On balance, UBS expects a final rate reduction of 25 basis points in the months ahead, probably after the next CPI is published and after the Australian dollar response to other central bank policy moves is noted.
Goldman Sachs believes the RBA has relied heavily on business surveys which suggest a gradual improvement in conditions is underway and employment growth has been sufficient to stabilise the unemployment rate. The broker finds this unusual as these are backward looking items.
Goldman, citing deteriorating trade balances, risk of severe drought and building approvals trending lower, finds it difficult to identify why, therefore, the RBA has concluded that conditions have improved materially.
This broker, too, will be keen to analyse the policy statement from the RBA to find more evidence for its rising optimism. There remains a chance that the RBA has merely delayed the rate cut until December but Goldman Sachs cannot envisage any benefit in waiting another month, other than to distance the central bank from the recent mortgage rate increases by the retail banks.
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