–  JUNE 2017 INSIGHTS BY THE CURVE TEAM –

Highlights

  • The RBA once again elected to leave the cash rate on hold at 1.50% following their June Board meeting.
  • Despite a slowdown in growth in Q1, the RBA remains optimistic about their forecasts.
  • Growing risks to the downside could see further revisions to RBA forecasts in the coming months.
  • Meanwhile the FOMC is still widely expected to hike rates again this week with the focus on their commentary around their balance sheet normalisation plans.

Rates Recap

  • The RBA left the cash rate on hold yet again in June with the cash rate remaining at 1.50%.
  • Governor Lowe in the post meeting statement remained confident in the outlook for growth despite a weak outcome expected for the first quarter.
  • After holding at their May meeting, the FOMC is likely to resume normalising interest rates by hiking again when they meet in June.
  • Discussions over the size of the FOMC balance sheet and when to start reducing it have gathered pace over the past month.
  • It is expected to mention this in detail at the June FOMC meeting which could have implications for the shape of the yield curve.
  • The growing divergence of monetary policy between Australia and the US could see the AUD come under pressure over the months ahead.

GDP Holds Up Amid Growing Headwinds

The Australian economy continued to grow in the first quarter, posting a gain of 0.3%. The increase takes the Australian economy’s run without a technical recession to 103 quarters, equalling the world record set by the Netherland between Q4 1982 and Q3 2008. Australia’s run which started in Q3 1991 has been remarkable given it spanned the Asian Crisis, tech bubble and GFC. While Australia is odds on to claim the record in three months time, the longer term outlook is far more uncertain.

Australia’s growth profile has been quite volatile in recent quarters. Growth unexpectedly fell sharply in Q3 last year only to bounce back in Q4, before slowing again in Q1 this year. Despite these turbulent times and a constantly changing composition of growth, the economy always manages to come out on top.

In the latest release there was a large drag on growth from net exports. This was largely a result of weather disruptions to exports due to cyclone Debbie. It also seems that the same reason was behind the build in inventories which helped to offset the negative impact of net exports. Mining inventories posted a large percentage gain last quarter, which should theoretically become exports over the quarters ahead.

The national accounts also confirmed that the construction boom, which helped cushion the impact of the fading mining investment boom, is now fading itself. While overall its remains at elevated levels, dwelling investment posted its biggest fall since 2009. The fall was broad based with only Victoria posting an increase for the quarter.

If the construction boom has in fact peaked, the economy will need another driver of growth to pick up and fill the gap that it leaves behind. One sector unlikely to come to the rescue is consumption, where the national accounts provided more evidence to suggest consumers are under pressure.

The composition of the 0.5% increase in household consumption over the quarter tells a very interesting story. The biggest increases in household consumption were electricity, gas and other fuels (2.9%), operation of vehicles (1.3%) and insurance and other financial services (0.7%), all non-discretionary expenses. Meanwhile the biggest declines in household consumption were alcoholic beverages (-1.0%) and clothing and footwear (-0.7%), both highly discretionary purchases.

One of the big hand brakes on consumption has been low wage growth. While the national accounts showed that compensation of employees was up a rather healthy 1% for the quarter, it comes on the back of a 0.7% decline last quarter leaving compensation up a measly 1.5% from the year. This goes some way to explaining why the savings rate continues to decline while consumption is hardly booming. With the savings rate now back around the long run average, unless it declines further, consumption will face further headwinds ahead.

With increasing the already huge debt household burden to fund consumption and housing market activity not desirable, businesses still reluctant to invest and the government unable to contribute as they attempt to hold on to the AAA rating, the questions remains: what will be the next driver of growth?

Outlook for Interest Rates

The latest GDP figures were released the day after the RBA’s June Board meeting; however, the weakness should have come as no surprise. Governor Lowe in his accompanying statement said that “Year-ended GDP growth is expected to have slowed in the March quarter, reflecting the quarter-to-quarter variation in the growth figures.” 

Despite the expected weakness, which was confirmed when the actual data was released the following day, the RBA remains confident in the outlook. The very next sentence after the one quoted above was: “Looking forward, economic growth is still expected to increase gradually over the next couple of years to a little above 3 per cent.”  

There was also no real change to the outlook for inflation with the statement going on to say that “inflation is expected to increase gradually as the economy strengthens.”

The conclusion from the statement above, and one that aligns with current market pricing, is that the current setting of monetary policy is consistent with the RBA’s mandate of fostering sustainable growth and stable prices over the medium term.

There are clear risks to the RBA’s outlook, risks that I would argue are to the downside. Until the data starts to shift outside the RBA’s expectations, we are unlikely to see a change in rhetoric, let along a change in the policy setting.

So for now it is a matter of assessing the incoming data and how it fits with the RBA’s ongoing narrative.

Australian Economic Highlights

  • After bouncing back in Q4 Growth slowed considerably in Q1 with the economy expanding by 0.3%. The Australian economy has now equaled the record for the longest run of growth without a recession at 103 quarters.
  • CPI picked up inline with with market expectations in Q1. Headline inflation rose 0.6%, taking the annual rate up to 2.1% and back into the RBA’s target band. The RBA’s preferred measure, core inflation remained below the band at 1.8% after a quarterly increase of 0.45%.
  • The employment data was firmer again in April with total employment rising by 37,400 after the solid increase of 60,900 the previous month. The monthly increase saw the unemployment rate ease back to 5.7% after the participation rate remained unchanged.
  • ANZ job ads eased back in May after a solid rise in April, posting a gain of 0.4% after last months revised rise of 1.5%.
  • The NAB business conditions index eased from a revised 13 to 12 in May, remaining well above the long run average of 5. Business confidence on the other hand fell heavily, dropping from 13 to 7 over the same period.
  • Consumer confidence printed below the key 100 level for the sixth straight month in May as consumers remain cautious on their own finances. The ongoing weakness in sentiment is starting to impact consumption.
  • After a weak run over the past four months, Retail sales were a little firmer in April. The headline increase in sale masked ongoing weakness in discretionary spending with the largely component, spending on food, accounting for most of the growth over the month.
  • Housing finance ease back again in April, a trend we are likely to see continue as the effects of increased macro-prudential oversights come to the fore. The number of owner-occupier loans and the value of occupier loans were both down, dropping 1.9% and 1.1% respectively. The value of investor lending was down 2.3%.
  • Australia’s trade surplus narrowed sharply in April, falling from $3.2bln to $555m. The main driver was a collapse in exports which were down 8% over the month on the back of a 45% fall in coal exports.
  • After collapsing 10.3% in March Building approvals pared back some of the decline, rising 4.4% in April. Total approvals are still down 17.2% on a year ago and more than 20% down on their August 2016 peak.
  • The uptick in Motor vehicle sales faded in April with sales only managing a 0.3% increase with sales now at the same level as a year ago.
David Flanagan

David Flanagan

Director: Interest Rate Markets