This note confirms the forecasts we released on 24 July that the RBA will cut the cash rate by 25 basis points (0.25%) on 1 October and again by 25 basis points on 4 February 2020.
That call updated our previous call on 24 May when we were the only forecaster (Bloomberg Survey on that day) to argue that the cash rate would fall below 1%.
We were feeling decidedly lonely with our October call
Over the last few weeks, markets had lost confidence in the October view. On 13 September, markets priced an October move with a probability of only 26%.
Over the course of last week, markets have moved to an 80% probability of this move.
What changed over the week?
The most important development was the release of the September RBA Board minutes. We were encouraged by the sentiments in the minutes.
Following the release of the minutes I wrote:
“The minutes of the Reserve Bank Board’s September meeting contain similar themes to the August minutes but indicate that the Board acknowledges that it is getting closer to its next move on policy.
In August the Board minutes concluded that: “Having eased monetary policy at the previous two meetings, the Board judged it appropriate to assess developments in the global and domestic economies before considering further change to the setting of monetary policy. Members would consider a further easing of monetary policy if the accumulation of additional evidence suggested this was needed to support sustainable growth in the economy and the achievement of the inflation target over time”.
In these minutes there is no reference to previous actions. Arguably reference to previous actions is a clear sign that the Board is content to observe developments whereas not referring to previous actions there is less emphasis on the need to wait.
It is also interesting that the theme that drove the June and July decisions to cut rates: “the Australian economy could sustain lower rates of unemployment and underemployment” was repeated in these minutes whereas that particular theme was absent in the August minutes.
Impacts on the monetary policy decision
The minutes refer to three “developments that had a bearing on the monetary policy decision”.
- The labour market – strong employment growth was recognised but the unemployment rate had remained steady at 5.2% (recall that the Governor has noted on other occasions that he would like to see the unemployment rate at 4.5%) and that wages growth “had remained low”. Indeed, the minutes point out that “the upward trend in wages growth appeared to have stalled”. We are aware that the Governor sees rising wages growth as the key to a sustained lift in spending growth and higher inflation. In addition, the minutes noted that “forward – looking indicators had continued to suggest that employment growth would moderate over the following six months”.
- The housing market – it was noted that there was “a turnaround in established housing markets” but from the perspective of economic activity there was “further weakness in dwelling investment in the near term” and low turnover in the housing market meant that “spending on home furnishings and other housing related items was not expected to contribute to consumption growth in the near term”.
- GDP growth – the Board meeting was held the day before the release of the June quarter national accounts. When the RBA released its forecasts on August 9 it was expecting GDP growth in the June quarter to be 0.8%; in the minutes it referred to an expectation of 0.5% due to the weakness of the partials in the lead up to the release. That forecast proved to be correct, but the minutes did note that “private final demand was expected to be weak”. (In fact, it was flat in the June quarter and down 0.4% for the year! – “weak” is probably an overstatement of the state of final demand).
With two meetings now having passed since the last move and, from my perspective, most importantly, the key rate cut theme that “the Australian economy could sustain lower rates of unemployment and underemployment” returning to the narrative, our central view that there is no reason to wait until November for the next move still seems reasonable.
Westpac continues to predict cuts in the cash rate of 25 basis points in both October and February next year.
Influence of the Fed
The second development in the week was the decision by the Federal Reserve to cut the federal funds rate by 25 basis points.
While this was a widely expected move it would have emphasised to the RBA, that following with the previous week’s move from the ECB global rates are falling.
Further, although there were apparent differences amongst Committee members the Chairman appears to be favouring policies that will maintain the expansion.
Chairman Powell saw “high value” in sustaining the expansion and was clear that “history teaches us it is better to be pro–active in adjusting policy”.
This approach indicates to us that, given our forecast is that growth will slow below trend through late 2019 and in 2020 the Fed is likely to be decisive in supporting the economy.
Implications of Australian employment
Finally, we saw the Employment Report for August last week. Note that the minutes emphasised the labour market as continuing to be central to the policy outlook.
The August Employment Report would have been very disappointing for the RBA although it reported a 37.4k gain in total employment. That is because the unemployment rate rose to 5.3% from 5.2% in July – a disappointing development given the strong increase in jobs (recall the Governor’s informal “target” of 4.5%, which he adopted when the unemployment rate was 5%).
It is important to remember how the results of the release are compiled. From the household survey, the ABS derives the various ratios on labour market performance; including the unemployment, underemployment, participation and employment to population ratios. These are which are then applied to an estimate of working age population to generate the level of employment, unemployment, underemployment and labour force.
Consequently, employment is likely to lift as population estimates pick up. This is why the recent softness in the labour market is being highlighted by rising unemployment rather than employment growth since those ratios in the household survey have been deteriorating.
The pace of growth in employment, and the change in participation, are correlated so it is not surprising that participation has lifted as employment remains robust – a strong labour market will bring more workers back into the labour force. But what is surprising this time is that the gains in participation are outpacing those for employment hence the trend rise in unemployment. This suggests that workers are entering the workforce due to a need for more income rather than only because employment conditions are improving.
If we focus on ratios, we can also see that the underemployment rate has lifted from 8.2% in June back to 8.6% in August.
We think the RBA is now firmly on board with this approach to assessing the labour market- strong jobs growth really reflects rising population and higher participation whereas the rising unemployment and underemployment rates are the true measures of the state of the labour market and its spare capacity. And of course, rising spare capacity puts downward pressure on wages growth (note in the minutes that the Board accepted that the upward lift in wages growth had recently flattened out).
Is the next one in February?
A realistic question is whether the follow up cut to the October move could come earlier than the February we currently expect.
One of the reasons why we argued consistently for October over the consensus view of November was that if global conditions deteriorated sharply near year’s end the RBA would like the flexibility to move again.
We think that the response of the Westpac Consumer Sentiment Index (down 4% in July as households seemed to be unnerved by consecutive moves) precludes another back to back move so going in October leaves available the flexibility to move in December. Waiting until November loses that flexibility.
We think the RBA would see the move to 0.5% as the low point in the cycle after which unconventional policies might be required. A prudent wait for that last move until early next year seems the most likely option.
Finally, Governor Lowe is scheduled to speak on the evening of 24 September. His speech on 21 May effectively signaled the rate cut which was delivered at the 4 June Board meeting.
Markets will be closely watching that speech.
Bill Evans is the Chief Economist at Westpac Institutional Bank. This material contains general information only. It does not constitute investment advice.
The forecasts given above are predictive in character and whilst every effort has been taken to ensure that the assumptions on which the forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The results ultimately achieved may differ substantially from these forecasts.