–  SEPTEMBER 2017 INSIGHTS BY THE CURVE TEAM –

Highlights

  • The RBA once again elected to leave the cash rate on hold at 1.50% following their September Board meeting.
  • Governor Lowe remained optimistic in the accompanying statement as data largely continue to support the RBA’s central forecasts.
  • Growth bounced back in Q2 after a weather disrupted slowdown to start the year.
  • There are growing concerns over the outlook for consumption which could threaten the outlook for interest rates.

Rates Recap

  • The RBA left the cash rate on hold yet again in September with the cash rate remaining at 1.50%.
  • In the post meeting statement Governor Lowe maintained his optimistic outlook on growth and inflation over the medium term.
  • Growth figures which were released the following day were in line with the RBA’s expectations.
  • While the RBA remains confident in the outlook, there is growing disquiet amongst members of the FOMC while the ECB is gearing up to announced the tapering of its QE program
  • These developments along with the data, weather events and geo-political tensions have seen the yield curve flatten noticeably in the US.
  • A similar move but to a lesser degree has occurred in the Australian yield curve while the rise in the AUD above 0.80 will have caught the eyes of the RBA.

Consumer Crunch Threatens Outlook

Another month has passed with the RBA once again remaining optimistic in its outlook after leaving the cash rate on hold at 1.50% for the 14th consecutive month. The headline data from the past month has given the RBA little reason to deviate from their current forecasts. GDP bounced back in Q2 in line with their expectation, employment growth remains strong and business confidence and conditions are at post GFC highs.

There is one big area of concern and it could threaten the long run outlook for monetary policy and interest rates.

While the mining boom, construction boom and now infrastructure boom have all helped Australia take the world record of 104 quarters or 26 years of growth without a recession, consumption is still the biggest component of the Australian economy.

This is one of the reasons that the RBA is worried about the consumer, especially the trend in wage and debt dynamics. The RBA’s stance on the blowout in Australia’s debt to income ratio has been widely publicised and for good reason. Not only does it pose a large financial stability risk but it could threaten the countries biggest driver of growth.

Consumption growth has held up remarkably well to date given the large numbers of headwinds that consumers face. Wages are growing at the slowest pace in decades at the same time as the countries debt burden reaches all time highs. Furthermore, consumers have been running down savings over the past 12 to 18 months in order to maintain the rate of consumption that we have become accustomed too.

The question that many people are asking is how long can the consumer keep this up?

The RBA is currently addressing the debt to income in balance in two ways. They are keeping rates low to help support the economy, create more jobs and hope that eventually a tighter labour market will lead to wage growth. At the same time through the Council of Financial Regulators they are targeting lending standards and growth rates in order to reign in growth.

Evidence to date suggests that there has been some success on the debt front. However it is still too early to tell if the current measures will be enough. The news is far less encouraging on the wages front. Wage growth has remained anaemic and if the international experience, where monetary policy has been far more aggressive and employment markets much tighter, wage growth may remain absent for some time.

With the RBA curtailing debt growth, wage growth absent and consumers only being able to run down savings so far, there is a real risk of a consumption crunch over the medium term.

Outlook for Interest Rates

As far as the market and the RBA are concerned, the outlook for interest rates hasn’t changed much at all over the past month. The current market pricing for the cash rate is almost exactly where it was a month ago. Currently there is no hike priced in for the remainder of this year with a hike not fully priced by the market until December 2018. This largely reflects the RBA’s comfort level in their forecasts.

The data over the last month has for the most part, been in line with RBA forecasts, supporting their positive outlook for the economy. Growth improved in the second quarter with the annual rate right in line with the RBA’s forecasts. The economy only needs to sustain its current momentum for the year end rate of growth to rise next quarter, something that the RBA is expecting.

With last years Q3 fall in growth of 0.4% set to drop out of the calculation, another expansion of 0.8% this quarter would see the annual rate of growth rise to 3%. That would make the RBA’s year end target rate of growth easily achievable with only a slight pick up needed for growth to lift in line with forecasts.

The sustained uplift in business conditions and confidence bodes well for both investment and employment. Key to the outlook is the expectation that the strength of the latter will eventually lift wage growth and with it underlying inflation. That transmission mechanism could take some time to kick in which is why the risks around inflation are key to the outlook for interest rates.

The next inflation update isn’t due until the end of October which means there is little chance of the RBA making any large changes in its rhetoric any time soon. With wage growth still weak according to both the quarterly wage data and national accounts, even an imminent pick up would take time to filter through to underlying inflation outcomes. That means that inflation poses no risk to the outlook anytime soon.

The balance of risks at present continue to point to the cash rate remaining on hold for the foreseeable future.

Australian Economic Highlights

  • Following a weather effected slowdown in Q1, Growth improved in the second quarter with the economy expanding by 0.8%. The Australian economy now holds the record outright for the longest run of growth without a recession at 104 quarters.
  • CPI was weaker than expected in Q2 with the headline reading of 0.2% short of the 0.4% expected. The result saw the annual rate fall below the RBA’s target band. The RBA’s preferred measure, core inflation also remained below the band at 1.8% after a quarterly increase of 0.5%.
  • The employment data remained strong for the fifth straight month with total jobs growth of 27,900 in July. It was enough to push the unemployment rate down 0.1%, even with a 0.1% increase in the participation rate.
  • The outlook for employment remains strong with the ANZ job ads report sustaining its trend of robust growth. Job ads were up 2% in August after a 1.6% rise in July.
  • The NAB business conditions index continued it’s strong performance in August with the index sitting at 15, remaining well above the long run average of 5. Business confidence posted an unexpected decline, falling 7 points from 12 to 5 and now sits below its long run average. One big positive was a jump in the employment index.
  • Consumer confidence continues to languish as weak wages growth and tightening credit standards continue to impact family finances. The ongoing weakness is starting to show up to a greater degree in consumption data.
  • Retail sales stalled in July with total sales flat from the previous month. The result was driven by sharp declines in discretionary spending while spending on food, the largest sector, was up 0.7%
  • Housing finance continues to be impacted by the macro prudential restrictions imposed by the council of financial regulators. Owner occupiers along with first home buyers continue to borrow at a solid rate, with lending to this sector up 2.2% for the month while investor lending slumped 3.9%, resulting in overall lending falling 0.6% ex- refinancing.
  • Australia’s trade surplus fell more than expected in July as the fall in the value of exports outpaced the fall in imports for the month. Volatlity in commodity prices continue to impact exports from month to month. The surplus declined to $460m, almost half the previous month.
  • Building approvals continue to trend lower, with the bounce in June being short lived. Total approvals in July were down 1.7% to be down 13.9% over the past year.
  • Motor vehicle sales struggled in the first month of the new fiscal year with total sales falling 2%. The fall left the annual increase in sales at 1.8%, well down on the previous month.
David Flanagan

David Flanagan

Director: Interest Rate Markets