Curve Monthly Insights
- The RBA delivered its second 25bp cut of 2015 in May, taking the cash rate to 2.00%.
- Despite some signs of improvement in household demand and employment, the RBA is still worried about the outlook for the Australian economy.
- As a result, the RBA lowered their forecasts in their quarterly Statement on Monetary Policy after the rate cut.
- Confidence still holds the key to a sustained recovery. The next test for confidence will come when the Government delivers the Federal Budget.
- The RBA eventually elected to lower the cash rate a further 25bp at their May meeting to 2.00% after speculation was evenly balanced whether they would in fact ease or pause for another month.
- The cut confirms what we had expected following their February Statement on Monetary Policy, in which the RBA lowered their forecasts (see charts below) with the assumption of market pricing, that expected two cuts, at that point in time.
- In the accompanying statement following the decision, Governor Stevens left the outlook for monetary policy rather vague, which saw the market price out expectations for another move, largely on the assumption that we are now at the bottom of the cycle.
- The RBA’s outlook has since been updated in their May Quarterly Statement on Monetary Policy which shows the RBA is still concerned with the outlook.
- The US interest rate curve has started to steepen once again in anticipation of the FOMC getting closer to raising their overnight cash rate in line with their goal to normalise interest rates.
- The market is currently 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 0.5% in Q4, up from 0.3% in Q3 against expectations of a 0.6% rise. The annual pace was lower at 2.5%. The result suggests that momentum in the economy remains weak.
- CPI increased by 0.2% for the second straight quarter in Q1, which was just above market expectations of a 0.1% rise. The increase saw the annual rate decline further to 1.3% from 1.7% in Q4. The core rate once again remained more stable, rising by 0.6%, slightly above expectations with the annual rate edging higher to 2.40%.
- After a solid run over the first quarter, the employment data softened in April. Total employment fell by 2,900 with a sharp decline in full time failing to be offset by a rise in part time employment. The unemployment rate edged up to 6.2% after the participation rate remained unchanged at 64.8%.
- Job Ads rebounded in April according to the ANZ Job Ads report. Total ads were up 2.3%, more than offsetting the 1.3% decline the previous month.
- Business conditions soured in April with the NAB Business Conditions index failing to hold its 4 point gain in March, falling 2 points back to 4. Business confidence remained steady in April at 3 after climbing out of negative territory last month.
- Consumer confidence extended its decline from March with a further 3.2% fall in April, taking the index well under the key 100 mark. The overall index is now down to 96.2, which is weaker than this time last year ahead of the budget when it was sitting a little more balanced between optimists and pessimists at 99.73.
- The pace of Retail Sales growth eased a touch in March with a 0.3% rise. Growth in the sales for the quarter ex inflation were once again positive, albeit a little slower at 0.7% for Q1 against a rise of 1.5% in Q4 last year.
- Housing finance was mixed in February with the number of owner-occupier loans up 1.2%. The value of occupier loans also rose 0.5% while the value of investor loans declined by 3.4%.
- The steady growth in the RBA’s credit aggregates continued in March with lending to investors still growing much faster than owner occupiers. The 0.5% monthly rise saw the annual rate remain unchanged at 6.2%.
- The rise in House prices continued to be driven largely by the Sydney housing market, with total capital city prices up 1.9% in Q4, 0.1% above expectations. The annual pace eased from 9.0% to 7.1%.
- Australia’s trade deficit was wider than expected in March at $1,322 however was narrower than the previous month after February was revised from $1,256 to $1,609.
- Building approvals continue to jump around, this time climbing 2.8% in March against expectations of a 1.5% fall. The steady increase saw the annual rate climb to 23.6% Medium density or apartment approvals continue to drive the overall result.
- Motor vehicle sales remained buoyant in March, rising 0.5% and are now 4.4% higher over the past year.
What it all Means – RBA Still Concerned With The Outlook
After Steven’s vagueness briefly allowed the market to toy with the thought that the RBA had reached the bottom of the easing cycle, that prospect disappeared as quick as it appeared with the release of the quarterly Statement on Monetary Policy. While the statement is full of insights and valuable information in all of its glorious 70 pages, it only takes a quick peruse through the Overview to assimilate the fact that the RBA is still concerned with the outlook. Below is just a couple of examples (our emphasis):
- Growth in the Australian economy is expected to continue at a below-average pace for a little longer than earlier anticipated and to pick up gradually to an above-average pace over 2016/17. The key forces shaping the outlook are much as they have been for some time
- The momentum building in household demand will, in time, provide some impetus to non-mining business investment, even though indicators of investment intentions suggest that non-mining business investment is not likely to pick up over coming quarters, as had been expected at the time of the February Statement
- The profile for GDP growth implies that there will be excess capacity in the labour market for longer than previously thought.
- The unemployment rate is expected to rise gradually and peak a little later than envisaged in the February Statement, before gradually declining towards the end of the forecast period
- The risks to the outlook for the global economy appear roughly balanced, other than for China where risks remain tilted to the downside.
- Further depreciation of the exchange rate seems both likely and necessary, particularly given the significant declines in key commodity prices, although increasingly divergent monetary policies in the major economies are also likely to have an important bearing on exchange rate developments.
It is clear from these excerpts that the RBA is still not comfortable with the outlook and if anything, it has deteriorated since their last update in February. This is also why they opted to lower the cash rate in May and why, despite having lowered the cash rate twice in 2015, they have revised their forecasts down even further following the February downgrade. The most recent revisions were only minor but are instructive to the RBA’s take on where the economy is headed.
The point above is the last one. The AUD remains a sore point for the RBA and has barely budged despite the two cuts so far this year. Their point above is relevant as ongoing QE programs from both the ECB and BoJ are making it hard for the RBA to put downward pressure on the currency by cutting rates alone. It is the FOMC however that largely holds the key for the AUD and the outlook for Australia’s monetary policy.
The Outlook for Interest Rates
Last month when we wrote The Outlook for Interest Rates we said “when the RBA cut the cash rate back in February, they did so under the assumption of market pricing at the time, which at the time had two interest rate cuts fully priced in for 2015”. We also said that May would be as good a time as any to deliver on that second cut as the next real opportunity would not come until August this year. With the RBA now delivering on that second cut, and concerns remaining over the outlook for the economy, how much lower could the cash rate go?
The RBA lowered both their growth and inflation forecasts in the latest SoMP suggesting that we can expect the economy to remain subdued for some time yet. These forecasts are based on a set of assumptions, one of which assumes the cash rate moves in line with market expectations. Even after the May cut, the market still had around a 50% chance that we would see another move by the RBA, compared to the 2 full cuts that were priced in when the February report was written. The RBA assumptions also included a slightly higher currency as well as higher commodity prices than those used in February. So when we look at the forecasts through that lens, we foresee further cuts from the RBA are far from a foregone conclusion. The big variable they can’t factor in is the FOMC. If Janet Yellen and her colleagues do finally act on their intention to normalise rates sooner rather than later, the impact should see the USD firm and help lower the value of the AUD, doing the job for the RBA. If that scenario were to materialise then the bottom could be in, if not, the RBA may have some more to do.
Another variable we haven’t covered this month is the Federal Budget which is due out tonight. Should we see any material impact on monetary policy arise from policy announcements we will provide an update to the outlook later in the week.