–  OCTOBER 2019 INSIGHTS BY THE CURVE TEAM –

Highlights

  • The RBA cut the cash rate to 0.75% in October, taking it to a new low.
  • Domestic data has shown little sign of improvement over the past month and employment data has actually deteriorated.
  • The domestic outlook combined with the trend towards lower rates globally drove the RBA’s decision to cut rates again.
  • Current trends, RBA rhetoric and market pricing all suggest that the RBA isn’t finished yet.

Rates Recap

  • After lowering the cash rate 25bp in June and July, the RBA lowered the cash rate a further 25bps to 0.75% in October.
  • Risks remain to the downside as the global outlook deteriorates and domestic demand remains weak. This has seen the RBA retain an easing bias.
  • Governor Lowe outlined in his recent speech at the RBA Board Dinner after the October Board meeting that this cut was required in order to maintain progress towards their employment and inflation targets.
  • That hasn’t stopped them from assessing potential unconventional monetary policy tools should a scenario arise that would require such action.
  • With the lowering of the cash rate, the past month has seen yield curves both here and abroad continue to flatten, as central banks cut rates or indicated looser monetary policy is likely over the months ahead.
  • Much of the outlook, especially from a global perspective still remains hinged on the outcome of the trade war which remains intractable and likely to drag out for some time.

RBA Trying To Get In Front Of The Curve

Australia’s setting of monetary policy moved further into uncharted territory this month. It was a continuation of the move away from what had become the RBA’s normal modus operandi. Up until the past six months, the RBA had a habit in recent years of announcing changes to monetary policy in the meeting prior to its detailed Quarterly Monetary policy statement.

With adjustments to monetary policy in June, July and now October, all months that do not include the release of their quarterly statement, the RBA is being forced to dance to the beat of a different drum.

There is good reason for this shift in approach. The RBA had remained steadfast on their glass half full rhetoric in the face of data that continues to deteriorate for now more than 12 months. Ultimately, it was an update on the employment market, in particular a reassessment of the level of full employment, that saw them cut rates in June and July.

Essentially, the RBA found themselves behind the curve and couldn’t wait until August, a month with a quarterly update, which would have usually been the next opportunity to cut the cash rate. In the intervening period, there has been little improvement in the domestic data. In fact, the unemployment and underemployment rates have actually drifted higher.

That prompted the RBA to act again this month, taking the cash rate to a new low; however, the domestic situation doesn’t tell the whole story.

For some time, the RBA has been quite vocal about the risks to the outlook emanating from the global economy. Political uncertainty is undermining confidence and resulting in a synchronised global slowdown with even the US not immune. The RBA highlighted this once again in the statement that accompanied this months decision to cut the cash rate, saying:

“While the outlook for the global economy remains reasonable, the risks are tilted to the downside. The US–China trade and technology disputes are affecting international trade flows and investment as businesses scale back spending plans because of the increased uncertainty.”

This is having a significant impact on the outlook which is in turn, impacting monetary policy settings around the globe. Accordingly, the RBA emphasised that:

“Interest rates are very low around the world and further monetary easing is widely expected, as central banks respond to the persistent downside risks to the global economy and subdued inflation.”

One of the key components of the overall setting of monetary policy, aside from the price of money, is the currency. While central banks generally adjust monetary policy to affect the price of money, what it does to their currency is often of equal importance. A loosening of monetary policy through a cut to the cash rate is also excepted to result in a weaker currency over time.

In his remarks as the dinner that followed the RBA’s meeting, Governor Lowe highlighted this point by saying:

“Central banks are responding to these downside risks by lowering interest rates. With inflation low – and expected to remain low – they are seeking to take out some insurance against the possibility of a noticeable slowdown in economic growth.”

His speech gave greater context to the following sentence that was added to the statement that accompanied the decision to cut the cash rate where the RBA said:

“The Board also took account of the forces leading to the trend to lower interest rates globally and the effects this trend is having on the Australian economy and inflation outcomes.”

What the RBA has effectively acknowledged is that not only does the domestic situation warrant further support, the global trends require they take further action. If the RBA doesn’t keep pace with other central banks globally, they risk an unwanted appreciation of the currency. An appreciation of the currency would actually result in a tighter overall setting of monetary policy.

So after finding themselves behind the curve only a few months ago, the RBA is now trying to get in front of the curve. Time will tell if it will actually work.

Outlook for Interest Rates

In the Statement that accompanied the decision to cut rates in October, the RBA made it clear rates will remained biased lower for some time. The final paragraph to the statement read:

“It is reasonable to expect that an extended period of low interest rates will be required in Australia to reach full employment and achieve the inflation target. The Board will continue to monitor developments, including in the labour market, and is prepared to ease monetary policy further if needed to support sustainable growth in the economy, full employment and the achievement of the inflation target over time.”

Following the meeting, the market still has a further rate cut fully priced in for February next year. A further cut, taking the cash rate to 0.25% at some point in 2020 is currently around 50% priced in.

Given the RBA’s action to date and the language they have been using, it seems likely we will see further easing of monetary policy. Another move this year can’t be ruled out. The market seems to have the risk of another cut this year underpriced given the RBA’s desire to get in front of the curve as central banks around the globe look set to act.

Another rate cut, taking the cash rate to 0.5%, takes the RBA further into unchartered territories and would open up questions as to when the RBA will look at Unconventional Monetary Policy Tools.

During his semi-annual appearance before parliament, Governor Lowe said “we are prepared to do unconventional things if the circumstances warranted it.” While he failed to elaborate on what circumstances would be required, he did say that:

“I think it’s reasonable to expect that we wouldn’t do it at the current level of interest rate, or even a bit below the current level of interest rate. We’d need to be very close to zero to do that.”

A cash rate of 0.5% is mooted to be the point at which the conversation of Unconventional Monetary Policy Tools will start to come into consideration. However, they could choose to follow the US Federal Reserve’s approach and take the cash rate closer to 0% before looking at alternative measures.

It is clear that Unconventional Monetary Policy Tools are something the RBA won’t be afraid to use. In his role at the Bank for International Settlements, the central bank to the central banks, Governor Lowe contributed to a paper that was released this week on that exact topic.

The core message from the paper titled ‘Unconventional monetary policy tools: a cross-country analysis’ was that these new policy approaches were “broadly effective”.

However the big caveat with that was, while “side effects have been contained and did not compromise the overall effectiveness of the interventions”, none of the central banks who implemented such policies have unwound them. As a result, “a complete assessment of their effects can only be made at a later stage.”

The report also made it clear the use of Unconventional Monetary Policy Tools requires the co-ordination of other arms of policy, such as fiscal and regulatory policy, to be completely effective.

As far as the outlook is concerned, we are still a little ways off these discussions coming to the fore. Market pricing combined with the domestic and global outlooks suggest we will see another rate cut on the near term horizon. From there, discussions on the outlook for monetary policy will get a lot more interesting.

Australian Economic Highlights

  • Growth printed in line with estimates again in Q2 with the economy only growing by 0.5% as the weakness from the first quarter continued. The annual pace of growth slowed further from 1.8% to 1.4% and is likely to undershoot the RBA’s estimate this quarter.  
  • Inflation came in slightly above expectations in Q2 with headline CPI printing at 0.6% for the quarter which saw the annual rate lift from 1.3% to 1.5%. The RBA has moved to using the trimmed mean as their preferred measure of core inflation and it increased by 0.4% for the quarter with the annual rate steady at 1.6%.
  • The employment data was well above estimates in August with 34.7k jobs added. Despite the high number of jobs created a concerning data point emerged, with a negative contribution from full-time role -15.5k and a positive 50.2K part-time jobs added. This saw the unemployment rate remain up at 5.3% along with yet another record high reading in the participation rate at 66.2%. 
  • The ANZ job ads stabilised with a small 0.3% increase in September, a significant uptick from a -2.6% print in August. This brings the year on year measure to -10.4%.
  • Business confidence posted a 1 point loss in September with the index falling to zero. Business conditions also remains below its long run average, gaining 1pt to print at 2 for the month. The crucial Employment index, continued its uptrend, adding a further point to print at 3. 
  • Consumer confidence fell back below the crucial 100 level, registering at 98.2. The declines were in all but one of the core categories. Short term expectations 1 year forward fell in both household finance and economic expectation terms.
  • After a soft second quarter, Retail sales edged up slightly in August. Despite the 0.4% gain market expectations for a large jump on the back of recent tax cuts haven’t eventuated in the data.
  • Housing finance showed signs of life in July with gains across the board. The value of owner occupier and investor lending were up over the month, rising 5.3% and 4.7% respectively. It appears recent headwinds to home lending are dissipating.
  • Australia’s trade surplus continued but fell back from recent records. The surplus came in at $5.9bln in August as solid revenues from exports, particularly iron ore and LNG continued.
  • After a volatile few months, Building approvals continued their downtrend. Approvals fell a further 1.1% in August bringing their fall to almost 50% from their late 2017 peak.
David Flanagan

David Flanagan

Director Interest Rate Markets