Curve Monthly Insights
- The RBA left the cash rate on hold once again in August at 2.00%.
- Three key communiques from the RBA over the month saw a subtle shift in the outlook for interest rates.
- Q2 is expected to be weaker than first thought however there are signs that things are improving.
- There are a number of risks to the outlook still in play with China and the FOMC front and centre.
- The RBA left the cash rate on hold at 2.00% as was widely expected.
- There were a number of subtle changes to the RBA rhetoric in the statement that accompanied the decision to remain on hold.
- The main shift was around the AUD where the statement now read “the Australian dollar is adjusting to the significant declines in key commodity prices” after “further depreciation seems both likely and necessary, particularly given the significant declines in key commodity prices” in previous statements.
- The subsequent Quarterly Statement on Monetary was far more informative on the outlook for interest rates.
- The US interest rate curve flattened as the front end of the curve continued to rise in anticipation of the first rate hike from the FOMC while the longer dated yields fell heavily.
- The market is still expecting this normalisation to get underway in the second half of 2015.
- This is very important for Australia as it will have a significant implication for our own setting of monetary policy.
Australian Economic Highlights
- GDP grew by 0.9% in Q1, up from 0.5% in Q4. The annual pace was lower at 2.4% against expectations of 2.1%. The result suggests that momentum in the economy remains weak but is buoyed by a lower AUD.
- CPI increased by 0.7% in Q2, which was just below market expectations of a 0.8% rise. The increase saw the annual rate rise from 1.3% to 1.5% after it was expected to rise to 1.7%. The core rate once again remained more stable, rising by 0.6%, slightly above expectations with the annual rate easing to 2.3%.
- Volatility continues to plague the employment data however the trend remained unchanged in July. Total employment rose by 38,500, split across both full time and part time jobs. The unemployment rate jumped from a revised 6.1% (previously 6.0%) to 6.3% after the participation rate jumped from 64.8% to 65.1%.
- After a solid run of late, job ads fell in July according to the ANZ Job Ads report. Job ads were down 0.4% after a robust rise of 1.3% the previous month.
- After substantial improvement in recent months, both business confidence and conditions soured in July. The NAB Business Conditions index fell from 10 to 6 while the Business confidence confidence index halved from 8 to 4.
- Consumer confidence remained on the back foot in July with the index falling by a further 3.2% to 92.2, adding to the 6.9% decline in June. The outlook for the economy continues to weigh on confidence with a result below 100 points indicating pessimists outnumber optimists.
- The pace of retail sales growth continued in June, rising 0.7% which was almost double expectations. Growth in sales for the quarter ex inflation were once again positive with the rise of 0.8% well ahead of the 0.4% the market was expecting.
- Housing finance bounced back in June with owner occupiers dominating the growth. The number of owner-occupier loans was up 4.4% while the value of occupier loans rose 5.5%. Investor lending was weaker once again with the value of investor loans down by 0.7% over the month.
- Faster prepayments by mortgagees weighed on the RBA’s credit aggregates. Total outstanding credit recorded growth of 0.4% in June which saw the annual rate of growth slip below 6% for the first time this year.
- The pace of house price appreciation continued to moderate in Q1, with total capital city prices up 1.6%, short of the 2.0% increase that was expected. The annual pace also fell short of expectations, coming in at 6.9% against 7.4% expected.
- Australia’s trade deficit headed wider again after returning back to earth from a record a month earlier. June’s trade deficit was almost right on expectations at $2.9bln, capping the largest quarterly trade deficit on record.
- Like the employment numbers Building approvals are also plagued by volatility, plunging by 8.2% in June after a revised rise of 2.3% the previous month. The annual growth in approvals fell from 18.3% to 8.6%.
- Motor vehicle sales were the big surprise in June, jumping by 3.8% as the end of the financial year beckoned. The jump took the annual pace of sale up from 0.8% to 4%.
Its All About The Trend
Looking at the trend can be very important when it comes to seeing through short term volatility. The employment and building approvals numbers have been testament to this fact for more than a year now as monthly statistics have seen wild swings in either direction. When stepping back and looking at trend rates, these outcomes can be seen in context.
The term trend has also been widely used when looking at currently levels of growth in the context of what has been seen as a long term growth rate. The subpar performance of growth in the post GFC economy has been characterised as ‘below trend’, suggesting that monetary and fiscal policy support is required to restore growth to something more akin to ‘trend’. Governor Glenn Stevens, in his speech at the Anika Foundation, which has been used in the past as a forum to launch thought provoking topics or challenge the current thinking on elements relating to monetary policy, touched on this particular topic of trend growth.
In looking at some of the markets explanations as to why the employment market had outperformed in the context of below trend employment growth, Governor Stevens made three observations, the third being the most significant:
To the extent that the data are hinting that our assumptions about trend growth may need to be revisited, that will be worth some discussion. It need not be the case that per capita growth would be any lower, if the lower growth simply reflects slower population growth. So there may be few implications for living standards as measured by income per head. But if there are assumptions about absolute growth rates embedded in business or fiscal strategies, or retirement income plans, they would need to be re-examined.
By broaching this concept during his speech, he laid the foundation for a subtle shift in the RBA’s outlook for the economy and interest rates. He made a subtle shift to the RBA language in the statement that accompanied the RBA’s decision to leave rates on hold in August. This time however it was focused on the AUD with Steven’s saying that “the Australian dollar is adjusting to the significant declines in key commodity prices” after saying in previous statements that “further depreciation seems both likely and necessary, particularly given the significant declines in key commodity prices”. This left the subsequent Statement on Monetary Policy as the platform in which Stevens would flesh out his recent remarks on trend growth.
Lower population growth has important implications for the economy. It lowers the growth in demand for goods and services, as well as the economy’s capacity to supply those goods and services. On the demand side, lower population growth would, all else being equal, be associated with less growth in consumption. Over time, it may also reduce the need to expand the capital stock through investment in residential housing, non-residential buildings, machinery & equipment and so forth. At the same time, lower population growth implies that there are fewer individuals available to be employed in producing goods and providing services.
Essentially what Stevens has said in the speech then again in the Statement on Monetary Policy is that what was previously assumed as trend growth may in fact now be lower than previously assumed. This is very important as it means that the RBA therefore has less scope to cut rates further than it would have previously. Conversely it also means that should the economy pick up in the future then the hurdle rate for an increase in interest rates would now be lower than it otherwise would have been. As you can see, that has significant implications for the outlook for interest rates.
Outlook for Interest Rates
Looking through the paradigm of potential lower trend growth, the outlook for monetary policy looks a little different than it did a month ago.
One of the key differences is the shift in the outlook for employment which stems from the discussion above. According to the RBA’s Statement on Monetary Policy:
The unemployment rate is forecast to be lower than previously anticipated. In part, this reflects the generally better-than-expected labour market conditions of late. Moreover, the unemployment rate is expected to remain little changed from the levels of recent months. This is despite the change to the forecast for aggregate demand, which is likely to be broadly matched by lower growth of the economy’s productive capacity, owing to lower population growth. Accordingly, the unemployment rate is now forecast to remain little changed over the next 18 months or so from a level that is a bit lower than had earlier been forecast, before declining over 2017 as demand growth picks up.
This is important as the previous forecast for a higher peak in the unemployment rate was one of the big drivers behind the elevated expectations of further cuts. If the unemployment rate is going to peak lower than previously expected, then the likelihood that another round of cuts will be required diminished somewhat.
The international backdrop has also changed over the past month. The situation in Greece has paled into the background while the volatility in both Chinese markets and their data has continued. Despite the uncertainty in China, according to the RBA, “the focus has shifted more towards how financial markets will react when the Federal Reserve starts raising its policy rate. This is expected to occur before the end of the year and is likely to be associated with an increase in global financial market volatility. There is also a reasonable chance that the Australian dollar will depreciate further once that tightening commences”.
The growing likelihood that the FOMC will raise its benchmark rate when it meets in either September or December and the fact that the Australian employment market looks set to outperform previous forecasts has seen the chance of further rate cuts diminish. The chance of further cuts hasn’t disappeared entirely however as there are still a number of risks to the outlook.
There are risks to the outlook, both from offshore and domestically. The biggest offshore risk remains China with the SoMP stating that:
The risks in China, however, remain somewhat tilted to the downside. There continues to be uncertainty surrounding the trajectory for growth and macroeconomic policy in China, and the implications for commodity demand.
This is one of the big reasons that the market is still not ruling out further cuts from the RBA. When combined with the fact that the RBA still thinks that “the economy is still facing some headwinds and it is likely to be operating with a degree of spare capacity for some time yet”, you have the market still pricing a 50/50 chance that the rates will be lowered one more time.