–  JULY 2017 INSIGHTS BY THE CURVE TEAM –

Highlights

  • The RBA once again elected to leave the cash rate on hold at 1.50% following their July Board meeting.
  • In the statement, Governor Lowe elected not to join the chorus of other central banks’ recent hawkish comments on monetary policy, maintaining a cautious outlook.
  • Supporting this view, were comments from RBA board member Ian Harper, who said that there is no reason “to scare the horses at the moment.”
  • While the RBA remains staunch in its outlook, markets took their lead from the other central banks’ hawkish comments, with the yield curve finishing the month significantly steeper.
  • The market moves come despite growing indecision among Fed board members’ current assessment of the ‘transitory’ pullback in economic and inflation data.

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.

Global Monetary Policy Maelstrom

It is a really interesting time for global monetary policy and the experiments that followed the global financial crisis. Central banks lowered their cash rates in unison, with some electing to go one step further, going down the path of Quantitative Easing, to support their economies from the fallout of the financial crisis. With a decade now passed since the early onset of the GFC, the return to normalisation seems anything but unison.

It is becoming more widely acknowledged that need to keep monetary policy settings at emergency levels has now passed. The US Federal Reserve is the first and only one of the major developed economy central banks to start the process of normalisations so far, but it hasn’t been without its challenges.

With 12 months between its first and second interest rate increase, the FOMC has now lifted rates four times in total and appears on track to start normalising their balance sheet by year end. They remain defiant in their path forward despite the data continuing to undermine their outlook, which is creating a great deal of uncertainty.

Adding to that uncertainty, is the litany of mixed messages coming from central banks over the past month. While the bank’s continue to issue official communications following Board meetings and the like, members of these boards and monetary policy committees are becoming more vocal around their own individual views.

The velocity of information is ever increasing thanks to technology, these views receive far more air time that they would have in the past, further clouding the outlook for monetary policy. Here is a quick around the grounds on what we currently know about the outlook for monetary policy from other major central banks:

The Bank of Canada seems the most likely to be the next train to leave the station and start removing the emergence setting of monetary policy. The Deputy Governor recently said that the worst is now behind us and the latest employment data has the chance of a hike tomorrow at 95%

The Bank of England had a large number of members dissent at their last meeting, instead voting for a change in the setting of monetary policy. Despite contradicting himself recently, Mark Carney seems resigned to the fact that if current trends prevail, the pressure on the BoE to move could see action later in the year.

The European Central Bank continues to be the most disjointed when it comes to trying to deliver a consistent message. Given the number of countries and opinions within the ECB is no wonder why. They seem to be following the FOMC’s playbook and will continue to downplay a shift in stance until its absolutely necessary.

The Bank of Japan meanwhile remains at the other end of the spectrum. After battling with deflation and disinflation for the best part of 30 year, the BoJ will definitely be the last to the party when it comes to removing the emergency setting of monetary policy.

The question is, where does this leave the RBA?

Outlook for Interest Rates

Going into last weeks Board meeting, there was growing expectations the RBA would join the chorus of other central banks flagging the removal of the emergency setting of monetary policy. That is what the markets reaction following the release of the accompanying statement suggested. Rather than seeing a change in rhetoric, the statement was a near carbon copy of the prior month. The thing is, do we actually have a setting of monetary policy that could be considered an emergency setting.

The situation the RBA finds itself in is more unique. The RBA did cut rates hard during the early days of the GFC along with other central banks. However, Australia also had the boost of a fiscal injection and a rapid rebound in the mining sector thanks to huge demand for our resources. This meant that our monetary policy setting didn’t reach the lows seen in many other jurisdictions.

In fact, after bottoming in April 2009 at 3%, the cash rate only remained there for six months. In October 2009, the RBA lifted the cash rate by 25bp. It turned out to be the first of 7 that would take the cash rate back to 4.75% by November 2010. Fast forward 12 months and the RBA cut rates again, kicking off a new easing cycling, eventually taking the cash rate to 1.50% where it stands today, half of the low point reached during the heights of the GFC.

Something that is often forgotten is the repricing of bank assets and liabilities since just before the GFC. Up until just before the GFC, the margin between the standard variable rate for a mortgage was 180bp above the cash rate. That margin had been unchanged for more than a decade. Since then the margin has increase by almost 200bp. A similar story can be said for the liability side of bank balance sheet as net interest margins are essentially unchanged over the same period.

That repricing over the past decade suggests that the effective cash rate is actually higher than the the offical rate of 1.5%. Obviously that is only a very simple analysis but the point that it makes is a very important one. That is, Australia is at a different point in its monetary policy cycle than those currently making noise about the need to remove emergence settings of monetary policy.

Importantly though, that is not to say Australia remains isolated from what is going on overseas. You only need to look at the jump in bond yields, including Australia’s over the past couple of months to see that. Despite no change in the outlook from the RBA, movements in our longer term bond yields are still heavily influenced by what happens in offshore markets.

Equally, another key input into overall monetary policy conditions, the Australia dollar, is also heavily impacted by what happens in offshore markets. All other things being equal, if monetary policy settings are being tightened offshore, then it should place downward pressure on our currency, assuming the RBA’s outlook remains unchanged. That would result in the overall monetary policy conditions in Australia easing, something the RBA would be wary of if the fall was to go too far.

That is just one of a myriad of different ways the RBA and Australia’s monetary policy could be impacted by what is happening offshore. That means that while the RBA will remain focused on the domestic economic environment, which at present suggests the cash rate is going no where for a while, it will have one eye on what is happening offshore.

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 in line 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 for the third straight month in May with total employment rising by 42,000 after the upwardly revised 46,100 last month. The monthly increase saw the unemployment rate fall to 5.5%, even with the participation rate up 0.1%.
  • ANZ job ads strengthened in June, posting a gain of 2.7% after May’s more moderate increase of 0.4%.
  • The NAB business conditions index lifted again in June with the index rising to 15, remaining well above the long run average of 5. Business confidence on the other hand remained a little softer with the index only up 1 point to 9.
  • Consumer confidence printed below the key 100 level for the seventh straight month in June, with the weakness in confidence becoming more broad based, rather than just centred around family finances.
  • After a weak start to the year, Retail sales were again a little firmer in May with total sales rising 0.6%. There appears to be a welcomed pick up in discretionary spending heading into the end of the financial year.
  • Housing finance Was mixed in May. The number of owner-occupier loans and the value of occupier loans were both up, rising 1.0% and 2.9% respectively while the value of investor lending was continued to fall, dropping down 1.4%.
  • Australia’s trade surplus increased significantly in May, rising to $2.47 bln from April’s $555m. The main driver was the rebound in coal exports, which jumped 62%, more than reversing the prior month’s soft figure on the back of Cyclone Debbie.
  • Building approvals resumed their downtrend in May, after a short-lived reprieve in April. Total approvals were down 2.6%, taking the year-on-year figure to -19.7%, and down 25% from their peak in August last year.
  • The uptick in Motor vehicle sales resumed in May with sales posting a 2.9% increase in comparison to April’s revised uplift of 0.6%. This boosts the year-on-year figure to 4.9%.
David Flanagan

David Flanagan

Director: Interest Rate Markets