Via Bill Evans of Westpac:
On February 21, Westpac Economics indicated that we believe that there is a case for two RBA rate cuts in 2019 – with the likely timing to be in August and November.
The recent March quarter CPI data reinforced our view that there is a case for rate cuts.
The debate is around when the RBA will come to this view as well.
The Reserve Bank Board meets next week on May 7. As we stated on February 21, we anticipate that the RBA Board will adopt a clear easing bias at the May meeting, prior to cutting rates by 25bps in August and in November.
That view was predicated on the Reserve Bank lowering its growth forecasts at the meeting, to trend in 2019 (2.75% from 3%) and below trend (2.5%) in 2020.
The “below trend” forecast for growth in 2020 follows from the consistent view from the Bank that the growth rate in 2020 will be below growth in 2019 by 0.25% due to “resource exports after 2019 will be at historically high levels contributing little to GDP growth,” (SOMP, February 2019).
“At trend growth” in 2019 is not sufficient to trigger a rate cut immediately but we expected that by August, when the next set of growth revisions would be made, the growth forecasts would need to be lowered further (to 2.5% in 2019 and 2.25% in 2020).
With underlying inflation persistently below the bottom of the 2–3% target band; growth forecast below trend and in conjunction with an existing explicit easing bias the case for a rate cut would be indisputable.
The emphasis in our analysis was around growth but we also confirmed an outlook of a gradual lift in the unemployment rate and underlying inflation persistently below the 2–3% band.
In research recently released we have also cast light on the so called “labour market/ growth puzzle,” pointing out that employment growth in cyclical industries (60% of the labour market) is already negative, although, being offset, for now, by the noncyclical sectors – government; health; education; utilities; and parts of professional services, which rely heavily on government spending.
We believe this process is largely playing out although acknowledge that the labour market (due to the cyclical/noncyclical imbalance) is somewhat stronger than expected.
However, once the Bank accepts that growth is likely to under shoot trend it should revise back its expected unemployment profile.
On the other hand, the recent March quarter inflation print was lower than we had anticipated.
Nevertheless, we expect that the Board will proceed along the lines we forecast in February with rates being on hold at the May meeting but adopting a clear easing bias.
Markets are priced 50/50 for a cut next week largely in response to the March quarter inflation report so we should consider this issue.
We expect that the revised inflation forecasts that will be released in the Statement on Monetary Policy on May 10 will show a “trimmed mean” forecast (note that the Bank is now forecasting “trimmed mean” in the tables rather than underlying inflation, which is the average of trimmed mean and weighted median) of 1.50% for 2019 and 2.00% for 2020.
It is important to note that the “trimmed mean” printed 0.3% in March above the 0.1% of the weighted median so the “shock” to the forecast will not be as great as the “average” measure.
That will be a down grade in the forecast from the February SOMP in the “trimmed mean” to 1.50% from 2.0% in 2019; 2.0% from 2.25% in 2020 and 2.25% (steady) in 2021 (to June).
This decision on the trimmed mean forecasts for 2019 and 2020 will be important for the timing of the rate cuts and the decision on the policy bias.
Note that the February SOMP adopted a 2% forecast for trimmed mean in 2019 (down from 2.25% in November 2018, when growth in 2019 was forecast at an extravagant 3.5%).
With the March quarter trimmed mean printing 0.3% the RBA could forecast either 1.5% or 1.75% for 2019. That would be on the basis of a 0.4% in the June quarter to be followed by a couple of 0.4’s/0.5’s in September and December. It is a line ball situation but the 2020 forecast is still likely to be 2.0% consistent with the gradually increasing theme.
Westpac assesses that a credible “trimmed mean “forecast would be 1.5% and consistent with the Bank adopting an easing bias.
The core rhetoric that the labour market will continue to tighten; pressuring wages; and eventually inflation will be emphasised and justify the lift to, say 0.5% in the December quarter, consistent with a 2% pace in 2020.
We are sceptical that such a dynamic can be relied upon in an economy that is growing below trend – we forecast GDP growth in 2019 and 2020 at 2.2%.
2019 is NOT like 2016
The markets are likely to be relying heavily on the precedent of 2016 for their “early” rate cut view. But there are considerable differences.
Recall that in 2016, following the March Inflation Report which printed underlying inflation at 0.2% for the quarter (market and RBA expectations of 0.6%) the RBA cut immediately at its May Board meeting.
Consider the differences:
• The underlying inflation forecast for 2016 was cut from 2.5% to 1.5% – a full 1.0% reduction (compared to the expected 0.5% reduction in 2019).
• The Board had an explicit easing bias going into the meeting: “Continued low inflation would provide scope to ease monetary policy further, should that be appropriate to lend support to demand” (April meeting). The current bias is not an explicit easing bias.
• There is a new Governor. Governor Stevens was clearly uncomfortable forecasting underlying inflation below the bottom of the 2–3% band – he had not been required to do that at any time throughout his tenure. Governor Lowe had been forecasting underlying inflation for 2018 below the 2–3% band for around half the time in 2017 and 2018
• In fact, in June last year he noted: “To try to get it back to 2.5 very quickly, it would be mainly through people borrowing more money, and having higher asset prices – I think that’s a much bigger risk to our economy than people having surprisingly low inflation expectations” (ECB Forum on Central Banking, June 2018).
The housing market is much more fragile than in 2016 and we see little risk in any over reaction by housing to rate cuts (as we saw in 2016) but Governor Lowe may remain cautious, for a little longer, given his strong emphasis on asset markets.
Politics
A decision to begin a new rate cut cycle 10 days out from a Federal election will be difficult. The precedents in previous elections are not relevant, although the Bank will be apolitical in its decision process. There has been some media speculation around the cut announced on August 6, 2013, before the September 7. There was a month of “clear air” before the election and it was the second stage of a cycle that began in May 2013.
Conclusion
The RBA is on track for two rate cuts and we favour August and November.
We think that a move next week will be a little early for the RBA.
In the Statement on Monetary Policy, which will be released on May 10, we expect that the key 2019 forecasts for growth (2.75%) and trimmed mean (1.5%) will have been be revised down (from 3% and 2% in February respectively) while the 4.75% unemployment forecast (by 2020) will be retained.
Those revisions will be sufficient to justify a clear easing bias (which is not currently present).
We expect that by August the growth forecasts for 2019 will be lowered further to 2.5% and the trimmed mean forecast for 2020 will be lowered from 2% to 1.75% while the unemployment rate forecast will also be lifted.
That will be sufficient to trigger the series of rate cuts which we expect for August and November.
Fair enough but at this point we’re talking brass tacks. They are coming.
