Expect rates to be on hold, for now: HSBC's Paul Bloxham
GUEST OBSERVER
A weaker jobs report and a pullback in surveyed business conditions suggests that local growth remains below trend.
At the same time, inflation is low, giving the RBA scope to cut further, if needed, despite its considerable reluctance to do so.
We expect the RBA to be on hold for now, but see another cut in Q2, unless the AUD sees a tangible fall before then.
The past month has delivered a modest pullback in the timely indicators of economic activity, from the much stronger numbers in late 2015. Some part of this may reflect a response to the recent financial turmoil, but it is also likely to reflect some correction for over-statement of the strength in the statistics late last year.
After reaching post-global financial crisis highs in Q3 and Q4 2015, surveyed business conditions have pulled back in December and January. Likewise, employment fell modestly in the past couple of months, following very strong growth in October and November (part of this reflects measurement issues in the official labour force survey).
Job advertisements and job vacancies have continued a modest trend higher, and consumer and business sentiment are around average. Although housing market auction clearance rates have picked up strongly in February, the daily house price numbers continue to show flat housing prices since August.
The modest pullback in the activity indicators leaves the economy growing at a solid, but still below-trend pace. We expect next week’s Q4 2015 GDP print to show growth of 2.5% y-o-y. This pace of growth is insufficient to generate a pick-up in inflation, and we continue to expect the underlying measures of inflation to drop below the bottom edge of the RBA’s target band in coming quarters. Wages numbers, published this week, show wages growth slowing to new lows, and this is expected to continue to weigh on domestic inflation.
A further fall in the AUD could help to lift inflation, but the AUD has been quite sticky at around US70-72 cents. With policy rates set to fall further in Europe and Japan in coming quarters and the market doubting whether the Federal Reserve will hike this year, the global backdrop is putting upward pressure on the AUD.
Speculative positions have recently shifted to ‘long’ the AUD/USD for the first time in nine months.
Despite the RBA’s considerable reluctance to cut the cash rate further, we expect they may have to cut around mid-year to keep inflation on target. We expect them to remain on hold next week but expect a cut in Q2.
Local activity indicators have pulled back a little
In recent quarters, the RBA has pointed to two key pieces of evidence that growth is lifting: surveyed business conditions and improvements in the labour market.
Both of these sets of indicators have started to pull back in the past couple of months.
Surveyed business conditions, which had been around their post-global financial crisis highs, fell in December and January (Chart 1). The official labour force survey has also shown that employment fell modestly in December and January, following very strong growth in October and November. In this case, we see part of the pullback as reflecting measurement issues in the official jobs numbers. Our own ‘labour market index’ suggests jobs growth of around 1.5% y-o-y, rather than the official numbers which show growth of 2.5% (See Downunder Digest: Is Australia’s jobs growth really that strong?, 11 February 2016). These indicators suggest that growth remains below trend.
Wages sluggish and investment outlook weak
The key question for the RBA is whether this below-trend growth will be sufficient to keep inflation on target? We remain doubtful. Underlying inflation is currently at the bottom edge of the 2-3% target band we expect it to fall in coming quarters. Despite steady improvement in the labour market, this week’s numbers showed that wages growth has continued to slow to a new record low on the 2.2% in Q4 2015 (Chart 3). State details also reveal that even the regions with the strongest labour markets, New South Wales and Victoria, are seeing continued sluggish wages growth (Downunder Digest: Rebalancing act drives state divergence, 25 February 2016).
This week’s capital expenditure survey, which contained the first estimates for financial year 2016/17, also showed that the outlook for business investment remains weak.
Unsurprisingly, mining investment is expected to fall further in 2016/17. At the same time, the capex survey showed that non-mining investment is expected to fall further in 2016/17. This partly reflects measurement issues, with the capex survey excluding a range of services industries, but also provides evidence that the investment outlook remains a challenge.
Housing market still appears to be cooling
Timely indicators of the housing market have been presenting mixed signals over recent weeks.
Auction clearance rates, which typically have a strong positive correlation with housing price growth, have jumped to quite high levels in February (Chart 5). However, this time of year is particularly difficult to assess, given the low turnover around Christmas means that sales are delayed until February. The daily housing price numbers show that housing prices have levelled out since August 2015, both nationally and in Sydney and Melbourne (Chart 6). We continue to expect the housing market to have cooled from its strong pace of activity in 2015 (see Downunder Digest: Australia’s housing market cools, 11 December 2015).
A rising AUD would be unhelpful
Besides low interest rates, the other mechanism that has been a key support for growth andinflation has been the lower AUD. This has worked through directly lifting imported goods prices but, even more importantly, it has improved Australia’s competitiveness. The combination of lower interest rates and the lower AUD have been the main drivers of the rebalancing of growth away from mining and towards the housing and services sectors. Tourism and education exports have been supported by the lower AUD.
Given the housing boom that has already occurred and the RBA’s increased concerns about financial stability in 2015, the central bank has shown considerable reluctance to cut its cash rate further to boost growth. The RBA would much prefer growth to be supported by a further fall in the AUD than by lowering its cash rate again. However, although the AUD is a long way below its peak levels of 2011, it has now been broadly steady for the past seven months, so is no longer continuing to loosen financial conditions. The AUD is also sitting at a level that is higher than is implied by its previous relationship with commodity prices (Chart 7). The current level of commodity prices implies that an AUD around US60-65 cents may be closer to ideal.
With policy rates set to fall further in Europe and Japan in coming quarters and the market doubting whether the Federal Reserve will hike this year, the global backdrop is putting upward pressure on the AUD. Speculative positions have recently shifted to ‘long’ the AUD/USD for the first time in nine months (Chart 8). For more on market positioning around the AUD, see Clyde Wardle and Daragh Maher, AUD bulls take over from the bears, 19 February 2016.
Recent RBA commentary on the AUD
Despite the AUD not having fallen with commodity prices in recent months, the RBA Governor, Glenn Stevens, has been reluctant to directly ‘jawbone’ the currency lower. At his recent semiannual testimony to a parliamentary committee (12 February 2016) the Governor noted that ‘there was a period when we felt that the exchange rate was not quite doing the job we might have expected, and we said so. It then adjusted, and our language has of late been, “it’s adjusting”. I would still say that. I would also note that commodity prices are continuing to fall as we speak’.
Last week, the market responded to some comments by an RBA board member, John Edwards, to The Australian (19 February 2016). Mr Edwards said ‘I still think it [the AUD] is a bit too high’ and that he’d be more comfortable with the ‘AUD trading around US65 cents’. However, as John Edwards also said to the Australian Financial Review (23 February 2016), ‘I can’t speak for the board at all, but I myself think I’m more comfortable with a lower dollar’. We do not view Mr Edwards’ comments as the commencement of an official RBA ‘jawboning’ campaign. Keep in mind that board members do not vote at the RBA, with the decision on the cash rate reached through consensus based on a recommendation by the staff.
Nonetheless, we think the RBA will be watching the currency carefully at the moment. Without a further fall in the currency (perhaps to around US65 cents) we expect the RBA may need to cut its cash rate further. Another bout of ‘jawboning’ the currency lower by the Governor may be just around the corner.
PAUL BLOXHAM IS CHIEF ECONOMIST (AUSTRALIA AND NEW ZEALAND) FOR HSBC.