Curve Monthly Insights.
- The RBA left the cash rate on hold in March at 2.00% despite some uncertainty around the outlook for interest rates.
- There was a key subtle shift in the accompanying statement suggesting that the RBA could be inching closer to a rate cut.
- The data is becoming as volatile as markets with indifferent readings over the past month.
- There are other key trends that could impact the RBA’s outlook for monetary policy over the months ahead.
- Despite steadily growing expectations, the RBA left the cash rate on hold at 2.00% in March.
- At first blush Glenn Steven’s accompanying statement looked eerily similar to the previous month’s statement.
- While the core message remained that the prospects for growth appear to be improving; “continued low inflation would provide scope for easier policy, should that be appropriate to lend support to demand”.
- This was a subtle shift from the previous month where he said “continued low inflation may provide scope for easier policy, should that be appropriate to lend support to demand”. We will expand on this in the Outlook for Interest Rates below.
- The outlook for the US economy is becoming a little more uncertain as recent data has been very inconsistent.
- This has seen the market lower their expectations for additional rate hikes from the FOMC a little further.
Cutting Through The Noise
The wild ride that kicked off the new year in January has continued through into February. The data has been as volatile as the price action in financial markets which is causing headache for traders, investors, economists, market commentators and central bankers alike. As a result, expectations for the economy and in particular interest rates are moving around by the day. Not helping that situation is the lack of liquidity in markets which means the market is moving significantly on even innocuous or minor data releases if they miss or beat expectations. Against this backdrop we are going to try to cut through the noise to look at the underlying trends.
The big release this month in Australia was the fourth quarter growth figures. The Australian economy continued to defy the odds, maintaining its stellar run of uninterrupted growth in Q4. This time it was the consumer who came to the rescue after the majority of partial indicators suggested there was a downside risk to growth for the December quarter. The economy grew by 0.6% for the quarter with household consumption accounting for two thirds of that.
The lift in consumption came despite a fall in wages. The average compensation per employee declined by 0.6% as more high paid jobs such as those that are in decline in the mining industry are being replaced by lower paying jobs in nursing and other services. This was also evident in the latest wages data which showed that wage growth has fallen to its slowest pace since records began more than 20 years ago. This meant that the lift in consumption in the growth figures was a result of consumers saving less with the savings rate, which is a derived figure from the national accounts, falling from 8.7% to 7.6% over the quarter. So there is a large question mark over the sustainability of the lift in household consumption.
The growth and wages data are largely historic now as we are now in March. The more recent data has been a little indifferent.
After robust growth in the total number of people employed in Australia throughout most of last year, the past two months has seen that growth start to splutter. Employment growth averaged 22,600 in 2015; however, over the last two months the total number of jobs has fallen by 800 in December and a more substantially by 7,900 in January.
Consumers however are more optimistic despite ongoing volatilty in financial markets and continued uncertainty surrounding the economic outlook. The Westpac consumer sentiment index jumped 4.5% over the month to be back up above the key 100 level, indicating pessimists outweigh optimists. Interestingly, it was consumers perceptions of their own finances that was the big driver behind the increase in overall confidence.
With so much noise, is it any wonder why there are so many differing opinions on the outlook for interest rates?
Outlook for Interest Rates
The outlook for interest rates is even more difficult to pin down than the noise the headline data suggests. In addition to the indifferent data releases over the past month, there are a number of other trends that could have an impact on the RBA and their outlook for the cash rate.
The simple one is the recent rise in the AUD. Since bottoming out in January after spending a number of days hovering just above 0.68, the AUD has risen 6 cents to be trading just above 0.72. Regardless of whether it be the stronger than expected GDP data or weakness in the USD that has been behind the move, it would have certainly caught the attention of the RBA. It is worth highlighting that it is not just the cash rate that determines overall setting of monetary policy, it is just one component. The level of the currency is another component that determines the overall calibration of monetary policy in an economy.
The lack of liquidity which has exasperated the volatility in global markets has also had an impact on the outlook for interest rates. The lack of liquidity and ongoing uncertainty has made it more costly for Australia’s largest banks to access offshore funding at a cost that is economically viable. This has forced the banks to turn to the local market for additional funding. With interest rates so low, retail investors are already looking at more attractive alternatives so the banks have been forced to turn to wholesale markets for this additional funding.
As a result of the greater demand for domestic funding, margins have been moving wider on long term debt issues as well as term deposits. The margin that the major banks have had to pay for 5 year bond issuance had bottomed at around +0.80% over 3 month BBSW last June and is now closer to +1.20%. This has driven spreads even wider for lower rated borrowers. Term deposit spreads have also widened with rates about 3% across the curve now the norm. We have already seen an out of cycle interest rate hike late last year, which the RBA determined at the time, didn’t need to be offset by an interest rate cut. There is growing pressure on the bank to raise rates again to maintain their net interest margin and profitability to ensure they maintain their capital positions that the regulator is keeping a close eye on.
We know from the subtle shift in the RBA’s language from this months statement that followed the decision, to leave the cash rate on hold, they inched closer to a rate cut. The upside surprise from the fourth quarter growth figures has bought them more time to assess incoming information as to how the economy is tracking. The RBA’s current stance is that there are “reasonable prospects for continued growth in the economy” however “continued low inflation would provide scope for easier policy, should that be appropriate to lend support to demand.
Given all available information, it is likely that the RBA will continue to sit pat for some time as previous adjustments to the setting of monetary policy work their way through the economy. The question is: with the data a little indifferent at present, are the prospects for growth strong enough to withstand a strengthening AUD and an out of cycle interest rate increase from the banks?
Appendix: Australian Economic Highlights
- Growth managed to beat expectations in Q4 with GDP rising by 0.6%, down from 1.1% in Q3 with the annual rate firming from a revised 2.7% to 3.0%. Household consumption was 0.8% higher over the quarter, accounting for two thirds of total growth as the services sector continues to do the heavy lifting for the economy.
- CPI increased by 0.4% in Q4, which was just above expectations of a 0.3% rise. The increase saw the annual rate edge higher to 1.7%. The core rate was a little firmer, rising by 0.5%, right on expectations with the annual rate easing to 2.00%.
- The employment data was softer again in January with further job losses on top of December’s decline. Total employment fell by 7,900 jobs with full time jobs falling a staggering 40,600. The unemployment rate rose back up to 6.0% with the participation rate remaining unchanged at 65.2.
- Jobs ads are becoming as volatile as actual jobs growth with the ANZ job ads report posting a decline of 1.2% in February. This comes on the back of a revised 0.9% rise in January and a decline of 0.3% in December.
- The NAB business conditions index recovered some lost ground in February, with profitability and trading conditions helping to boost overall conditions. Business confidence index remained little changed at 3 with the gloomy outlook offshore weighing on confidence despite improved local conditions.
- A return of relative stability in markets ahead of the survey helped Consumer confidence improve in February with the index edging back above 100. Confidence rose 4.2% taking the index up to 101.3. An improved outlook for consumer own finances was the big driver behind the recovery after consumers perception of their own finances took a dive in January.
- After stalling in December the pace of retail sales picked up a little in January. Retail sales were up 0.3% in the first month of the new year which was just short of estimates. Retail sales continues to be a less reliable guide of overall consumer activity as spending on services continues to outpace retail spending.
- Housing finance produced a moderate gain on the back of Decembers resumption in new lending approval growth. The number of owner-occupier loans was up 2.6% with the value of occupier loans rising 0.9%. Investor lending posted a small increase of 0.6% as lending continues to prefer other mortgage sectors.
- There continues to be a transition away from investor lending in the RBA’s credit aggregates with a steady pick up in Business lending filling the void. Lending to owner occupiers remains steady. The growth in total outstanding credit continued to chug along with growth of 0.5% which saw the annual rate of growth ease a touch to 6.5%.
- Australia’s trade deficit printed close to $3bln in January after eclipsing that figure 5 times in 2015. The small improvement in the deficit from December’s $3.5bln was a net result of a 1% rise in export receipts and a 1% fall in imports.
- Building approvals continued to see-saw in January, falling 7.5% after the previous months 8.6% decline. Despite the volatilty the trend continues to point south with approvals now down 15.5% compared to a year ago.
- Australian’s love affair with SUV’s is resilient and is single handedly keeping motor vehicle sales on the rise. Total sales are now up 5.1% over the past year with SUV sales up 23.3% over the same period. At the current trend, SUV sales will outpace passenger vehicles in the next few months.