Australia | May 04 2016
– Many an economist has been surprised by yesterday's RBA rate cut
– Since inflation is unlikely to pick up soon, another cut is anticipated
– Deutsche Bank predicts more than one additional 25bp cut is needed to spur on inflation
By Greg Peel
Heading in yesterday’s RBA policy meeting, the market was factoring in a 50-50 bet of a rate cut. Such a view was corroborated by economist forecasts, which were also split down the middle. So yesterday, half the market was quite surprised.
In the wake of the cash rate cut to a new record low 1.75% from 2.00%, economists agree on two things: it was the March quarter CPI numbers that pushed the central bank over the line, and on that basis there will be another follow-up cut soon, most likely in August after the June quarter CPI numbers are known.
Commonwealth Bank’s economists were among those surprised by the cut. In their view, “the domestic economy does not need additional support”. GDP growth remains comfortably positive, CBA suggests, as does jobs growth. The ramp-up in infrastructure spending announced in the federal budget will take pressure off monetary policy, as the RBA has called for.
The decision to cut was therefore all about a level of concern about the inflation trajectory. CBA believes this concern is overdone. Glenn Stevens noted in the policy statement that “the quarterly data contain some temporary factors,” and CBA considers some of the deflationary elements of the March quarter data to be less than concerning.
Not all CPI elements witnessed deflation in the quarter, CBA notes. Those that did include lower prices due to increased competition, which is positive, lower prices due to heavy post-Christmas discounting, which has now run its course, a slower housing market, just as the RBA was hoping for, and lower oil prices working through the cost chain, which will reverse.
Moreover, the RBA’s own modelling suggests 100 basis points of rate cuts would add a mere 0.1 to 0.2 percentage points to the inflation rate over a year. Lower interest rates are therefore not the solution to low inflation, just as lower rates are not, CBA suggests, the path to sustainable economic growth.
That said, CBA is tipping another rate cut in August. It is clear the RBA is concerned about entrenched low inflation.
UBS’ economists are among those confused by Glenn Stevens’ suggestion that “labour market indicators have been more mixed of late”. The unemployment rate has fallen and indicators of hiring intentions have been strong.
But wages growth is the major driver of consumer price inflation, thus March quarter disinflation suggests this is the missing element. Stevens suggested in his statement that “ongoing very subdued growth in labour costs and very low cost pressures elsewhere in the world, point to a lower outlook for inflation than previously forecast”.
In his April statement, Stevens noted “new information should allow the Board to assess the outlook for inflation and whether the improvement in labour market conditions evident last year is continuing,” while keeping the cash rate on hold. It seems he got his answer.
It’s quite a turnaround from the Stevens of only a month or two ago, who seemed very upbeat about the falling unemployment rate and the strong GDP result in the December quarter, and one who indeed himself questioned what value another rate cut could even provide. At that stage the market was beginning to question whether 2.00% might just be the floor. But back then it was assumed the Fed would press on with further rate hikes. And one presumes that when Australia’s CPI data hit the wires, Stevens turned white as a sheet.
The currency has now become a “complication”, in other words a reason to cut. The prospect of fuelling a dangerous housing bubble has now eased following tightened macro-prudential regulations, removing a reason not to cut. While the recent bounce in commodity prices is a welcomed driver of the Aussie dollar complication, the terms of trade still remains much lower than it was a year ago. Thus no reason not to cut.
It just came down to inflation.
The cut surprised Westpac. But clearly, the bank’s economists suggest, inflation has become the most important policy driver. And it is unlikely the June quarter CPI numbers will provide the RBA with any renewed comfort, therefore it is hard to believe the RBA would not take the opportunity to cut again following the June report release, implying an August cut.
UBS agrees, although does not see another cut thereafter either this year or next.
ANZ Bank’s economists believe the RBA is likely to follow up with another cut in the near term, while the St George Bank economists expect the central bank to hold off for a few months.
Morgan Stanley’s economists had been expecting the RBA to cut, but they weren’t exactly sure when. They now expect a cut in August, but believe 1.50% should provide the trough that should manage to deliver a “still-bumpy” economic growth transition. Much will nevertheless depend, the economists suggest, on how the cut impacts on the housing market and whether the RBA is afforded any support from fiscal policy reform in the second half of the year.
Macquarie economists had previously tipped a May rate cut, then tempered their view due to the strong jobs numbers, before immediately reinstating May rate cut expectations the minute they saw the March CPI report. Yet Macquarie is not among those assuming an August rate cut is nigh.
Most economists are now of the view that if the market was pricing in a 50-50 chance of a May rate cut, the RBA’s clear focus on weak inflation ensures the market will more emphatically price in a further cut. But Macquarie suggests this will bring down the Aussie dollar by enough to see the RBA hold off.
Macquarie is tipping November.
Given it takes a relatively large move in the exchange rate to have a relatively small impact on inflation, Deutsche Bank suggests moving Australian inflation back into the 2-3% target band over the next few years “is likely to ultimately require the market to conclude the cash rate is heading toward (indeed below) Fed funds”.
Let’s stop and think about that one for a moment.
The current Fed funds rate is 0.25-0.50% with little sign as yet of any reason to hike again until at least later in the year. To get below that level would require quite a number of RBA rate cuts from the new record low of 1.75%. Economists agree a shift back to a more dovish stance by the Fed is another factor which drove the RBA’s move yesterday.
But assuming the Fed does start to raise down the track, then it is not beyond the realms another cut or two from the RBA could take a lower RBA rate to below a higher Fed rate. Either way, Deutsche Bank does not believe the RBA would be of the view a rate below Fed funds is needed, but “given the 50bps of easing in 2015 had no noticeable impact in lifting wages growth or consumer price inflation it is hard to see a cumulative 50bps of easing this time as ‘doing the job’”.
Deutsche is expecting a 25 basis point cut in August followed by another in May next year.
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