Australia | Apr 06 2016
By Greg Peel
The State of Play
Nobody expected the RBA to cut its cash rate yesterday. A record low rate of 2.00% remains in place. But much anticipation preceded yesterday’s RBA policy meeting nonetheless.
There was no expectation of a rate cut given the RBA has, over the past few months, painted a relatively positive picture of the Australian economy. The stronger than expected December quarter GDP result underscored the central bank’s belief the economy is managing to transition away from dependence on mining and energy investment and towards more widespread contribution from non-mining sectors. Growth ahead is likely to be below trend, but not worryingly so. Certainly not enough to require a cut to an even lower record cash rate.
And we should recall that RBA governor Glenn Stevens has not so long ago questioned the value of further rate cuts to so low a base rate. While a 25 basis point cut from 2.00% to 1.75% represents a far greater percentage drop than a cut from say 7.25% to 7.00%, if businesses and households aren’t rushing out to borrow at 2.00%, why would 1.75% make the difference?
Nevertheless, the RBA remains in an easing bias. While talking up the Australian economy in the past several months’ policy statements, Stevens has ended each statement with an assurance that current low inflation does provide scope for another cut and that the central bank will monitor the situation.
The major source of the RBA’s upbeat assessment is the labour market. Despite dire warnings from many an economist over the past twelve months, Australia’s unemployment rate has not shot up to 6.5% or higher. Those predictions were largely based on expected mass job cuts across the resource sector. What they did not anticipate was a sufficient counter-balance to date of jobs growth in other industries, such as retail and health.
Yet Stevens, like many others, appears to have been left scratching his head. An unemployment rate under 6% is heartening, but curiously surprising. It is for that reason the last couple of RBA policy statements have suggested that the RBA board would keep an eye on new information to decide whether inflation will remain low and whether “the improvement in labour market conditions evident last year is continuing”.
Current low inflation provides the RBA with scope to cut rates further. A strong labour market suggests the potential for wage growth, which would flow into higher inflation in the usual higher wages equals more spending power equation. Take away labour market strength and the low inflation issue almost ensures another rate cut.
That’s the domestic picture. The other factor is the global picture, which is crystallised in the form of the exchange rate. The “Aussie dollar”, meaning AUDUSD, is the benchmark exchange rate but even as this threatened to drop below US70c last year, Stevens pointed out the AUDEUR, AUDJPY and other cross rates were going the other way and the US is not Australia’s only trading partner. And far from its biggest.
When the Aussie dollar was trading above parity not so long ago, the RBA called it “overvalued”. The world was seeking yield and Australia was offering a solution, thus forcing up the exchange rate above and beyond what the usual commodity price relationship would suggest. So when the resource sector turned south, the RBA went into cutting mode. Finally last year we saw an Aussie more in line with what value would suggest.
But we’ve since seen a bounce. Just when economists were forecasting an exchange rate of US65c, we shot back up over US75c. Just when many non-mining industries in the Australian economy were starting to see the benefits of a weaker Aussie after years of crippling currency headwinds (think tourism for example), the breeze stiffened once more.
The Complication
Yesterday when the RBA statement released confirming no rate cut, the Aussie shot up about half a cent. This seems strange given no one was expecting a rate cut, but what was expected was some so-called “jawboning” from the RBA governor, meaning a suggestion that the Aussie was “overvalued”.
Currencies move in anticipation of rate changes. They do not wait for confirmation. So if a central bank suggests currency overvaluation, the implication is “and if it stays that way we’ll have to cut”. The currency thus falls anyway, and the desired outcome is already achieved.
Glenn Stevens did not “jawbone” down the Aussie yesterday with a typical “overvaluation” call as the forex market clearly assumed. What he said was:
“The Australian dollar has appreciated somewhat recently. In part, this reflects some increase in commodity prices, but monetary developments elsewhere in the world have also played a role. Under present circumstances, an appreciating exchange rate could complicate the adjustment under way in the economy.”
Stevens has broken down the Aussie’s rebound into two parts. One is the rebound in commodity prices which, if sustained, is welcomed, in which case a stronger Aussie is counter-balanced by greater resource sector earnings. The other, however, refers to the simple relativity of exchange rates. In Japan the cash rate has moved into the negative. In the eurozone it's now zero, although most individual European banks have now set negative rates. China’s rates remain positive but the central bank continues to ease by other means.
Even New Zealand saw a cash rate cut at the last RBNZ meeting.
It is clear that central bank easing across the major economies of the world is the primary reason why the US Federal Reserve is not going to pursue a quarter by quarter tightening policy as was assumed in December last year. By default, if everybody else cuts, you have raised on a relative basis. Thus it follows that while the domestic scenario in Australia is not yet one that warrants a rate cut in isolation, the strength in the Aussie implies we’ve effectively had a rate rise in relative terms.
And that could “complicate” the issue.
The Debate
Having leapt half a cent on the RBA statement release yesterday, the Aussie dollar promptly fell a cent. Glenn Stevens did not call the Aussie “overvalued” as he has done so often in the past, he simply suggested the matter is “complicated”. Central bankers are not known for being blunt. But it is not a stretch to assume Stevens is preparing the market for a macro “excuse” to override the domestic picture and cut the cash rate.
Or is he?
“On our reading, it is now quite clear that the RBA is close to acting on its easing bias,” say the Macquarie economists. “The RBA has reached a point of discomfort around the A$”.
Macquarie makes note that strength in the labour market has prevented a rate cut up to now, from a domestic perspective, despite low inflation. But recent employment data have actually been weaker. The ANZ job ads series has topped out, it appears, and Macquarie points out that were it not for a fall in the participation rate in February (job seekers giving up hope), the unemployment rate would have been 6.2%, not 5.8%.
Macquarie is forecasting a 25 basis point cut at the May meeting.
Goldman Sachs had already pencilled in a May rate cut, so yesterday’s statement only serves to underscore that forecast. The “complication” is one reason, but a terms of trade which remains “much lower than in recent years,” as noted in the statement, is the other.
Goldman concurs with Macquarie’s assessment of the labour market, and further points to declining private capital expenditure expectations in 2016 as well as “clear trend declines” for retail sales and building approvals.
Morgan Stanley concurs with Goldman’s assessment of a weakening Australian economy. Morgan Stanley’s economists had already pencilled in rate cuts in both the September and December quarters, down to 1.50%, and they have not changed their view.
UBS does not believe yesterday’s statement signal’s an “imminent” rate cut. The UBS economists cite ongoing moderate growth in the global economy, Australia’s 2015 growth pick-up, better global financial market sentiment (than earlier this year, presumably), and the commodity price rebound, part of which reflects recent improved data out of China, as reason the RBA would be in no rush.
The rebound in the Aussie dollar does “lower the hurdle,” but despite believing that if Australia’s cash rate goes anywhere this year it’s down, UBS still believes the RBA is likely to remain on hold in 2016.
If you laid every economist in the world end to end, they say, you still wouldn’t reach a conclusion. All the economists quoted above see the “complication” factor as suggesting the RBA either will or has more scope to cut sometime soon. But ANZ Bank’s economists see “complicated” as suggesting the RBA “is unlikely to react in a mechanical fashion to the stronger dollar,” even if it does make the board uncomfortable.
The St George Bank economists are of a similar mind:
“There was little to suggest that the RBA has changed its stance in monetary policy. We continue to expect that the RBA will leave rates on hold throughout 2016. We do not believe that the RBA would cut the cash rate simply to target the AUD but a rise in the AUD without a corresponding rise in commodity prices would give them pause for thought.”
So, how do we interpret the word “complicate”?
Is it a “complication” that global central bank easing has driven the Aussie higher and hence this “outside” factor can only be corrected with a rate cut? Or is it a “complication” because the RBA, charged with a mandate of managing Australia’s economy, would never cut the cash rate because of what the rest of the world is up to?
Perhaps we can take comfort in the first and second laws of economists. The first law is that for every economist there is an equal and opposite economist, and the second law is that both of them are wrong.
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