Rate cuts still likely, but ANZ says doom and gloom takes a back seat

Rate cuts still likely, but ANZ says doom and gloom takes a back seat
Rate cuts still likely, but ANZ says doom and gloom takes a back seat

GUEST OBSERVER

Market sentiment has turned more positive, in part because participants realise that the US economy remains solid and as China concerns abate. 

Strong US jobs growth in February boosted risk sentiment and reduced recession fears. 

The RBA remained on hold as expected. Q4 GDP data showed that the economy recorded a strong finish to 2015. 

We still expect further RBA rate cuts, but the data are challenging this view and risks are skewed toward policy easing occurring later than we forecast. 

China nominated a 6.5-7% GDP growth target for 2016. 

INTEREST RATE STRATEGY 

Yields finished higher after a white knuckle ride for the Australian front end last week. 

Risk-on sentiment globally helped push yields higher. 

Focus to remain on higher funding costs as a major bank announced a rise in investor housing loan rates. 

CURRENCY STRATEGY 

The USD is struggling as the data pulse remains strong, but Fed rhetoric remains dovish. This, together with the solid GDP outcome in Australia, is keeping the AUD elevated. 

The sustainability of these AUD levels will depend on the market volatility remaining subdued. 

COMMODITY STRATEGY 

Low prices induce supply response in copper. 

Iron ore supported by hope of further policy support in Chinese steel sector. 

Investor demand for gold remains robust. 

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Rate cuts still likely, but ANZ says doom and gloom takes a back seat

RBA ON HOLD… 

As widely expected, the RBA kept the cash rate on hold at 2 percent last week. The Bank continued to take a positive view of the Australian economy, noting that “the expansion in the non-mining parts of the economy strengthened during 2015”. 

We interpreted two small changes to the Governor’s statement as slightly on the dovish side. First, the Bank noted that low inflation “would” provide scope to ease further rather than its prior reference to “may”. Secondly, the AUD was characterised as “has been adjusting” versus “has continued its adjustment”. Clearly, the Bank would still prefer a lower AUD which has subsequently pushed higher to USD0.74. The Bank would likely become more vocal on the currency again if the activity data started to soften. 

…WHICH WAS JUSTIFIED BY Q4 GDP 

The slightly more dovish tone from the Bank, however, came before the strong Q4 GDP print. Not only did Q4 GDP surprise on the upside at 0.6% q/q, upward revisions meant that growth over the year was well above expectations at 3 percent. The Bank had been flagging the potential for GDP revisions and this rate of growth helps to square the apparent disconnect with the strong labour market data last year.

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Rate cuts still likely, but ANZ says doom and gloom takes a back seat

The Bank would have been heartened by the pick-up in household spending. A key feature of the Bank’s forecasts is a strengthening in household spending to slightly above the long-run average of 3 percent. Household consumption grew 2.9 percent y/y in Q4. 

Housing construction also remained strong (+2.2 percent q/q; 10 percent y/y) in Q4. A significant backlog of work is supporting activity at record levels, especially in the key Sydney and Melbourne markets but lower approvals numbers suggest this growth impetus will wane.

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Rate cuts still likely, but ANZ says doom and gloom takes a back seat

Meanwhile, business investment fell as expected. Engineering construction drove the quarterly fall as resources projects, particularly LNG, continued to approach completion. But the news on the investment front was not all one-way traffic, with both machinery & equipment spending and non-residential building rising solidly in Q4, the latter despite falling building approvals and a shrinking backlog of work. 

Overall, there were plenty of positives in the national accounts. Growth continues to broaden beyond the mining sector, and the pick-up in consumer spending will be particularly encouraging for the RBA. As such, the economy is on a much firmer footing than previously envisaged. 

WE STILL EXPECT FURTHER RATE CUTS 

Despite the improvement in the economy over the second half of 2015, we continue to expect further RBA rate cuts this year. Our call for the first rate cut to occur in May, however, is being challenged by the incoming data. 

We maintain that the contribution to growth from property market activity – not just housing construction – will ease over 2016. Dwelling construction directly added .ppt to Australia’s GDP growth in 2015 but this is unlikely to be sustained. While the level of building activity will remain high, the fall in residential building approvals over the past year suggests that the impetus to growth will wane (Figure 3).

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Rate cuts still likely, but ANZ says doom and gloom takes a back seat

 

There are also risks around household spending. While household consumption strengthened over 2015, this was against a weak income backdrop and was heavily assisted by a sharply lower saving ratio (Figure 4).

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Rate cuts still likely, but ANZ says doom and gloom takes a back seat

Presumably, the falling saving ratio can be partly attributable to a ‘wealth effect’ amid strong dwelling price growth. But this is expected to wane this year amid slower house price growth (and as equities have weakened). Some of the savings decline, however, will reflect consumption smoothing, with evidence of this particularly in the mining states of WA and Queensland that ran up savings during the commodity price boom. 

More timely data on retail sales (released last week) show that spending has been soft in recent months, with no growth in December and a modest 0.3 percent m/m rise in January. 

With unemployment expected to remain around 5¾– 6 percent, spare labour market capacity will continue to weigh on wages growth. In all, it is difficult to see household consumption accelerating further from here. Consumption growth falling below the RBA’s expectations would certainly increase the likelihood of further rate cuts.

Surveyed business conditions have moderated in the early months of 2016, indicating some slowing in non-mining activity. Ahead of the important NAB survey tomorrow, however, Ai Group’s surveys for February continued to show some consolidation in aggregate at above-average levels (Figure 5). Business confidence may be further weighed down by the negative global sentiment in February.

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Rate cuts still likely, but ANZ says doom and gloom takes a back seat

Overall, the incoming data on the Australian economy has remained OK and, for now, allays any concerns about the renewed strength in the currency. China’s target of 6.5–7 percent GDP growth for 2016, coupled with slightly higher budget deficit, lending and money supply growth targets, will also help to further calm anxiety about that economy. 

The rate cut we have pencilled in for May is less than two months away so clearly the risks are skewed towards further RBA policy easing kicking off later than we expect. Markets are only pricing one full rate cut for this year. 

Despite weak wages growth, we can’t rule out being surprised on the upside by household spending. There is room for household saving to fall further to support stronger-than-expected consumption. Housing markets have commenced 2016 in a relatively positive fashion, with auction clearance rates rebounding in Sydney and Melbourne, while price growth has stabilised at solid rates. If these early indicators translate into a second wind for building approvals, the risks would be to the upside for housing construction. Moreover, the RBA would likely be uncomfortable reducing the cash rate further in the face of ongoing strength in house price growth. 

Working in the opposite direction, however, are that the global growth backdrop remains fragile, our interest rates continue to look ‘high’ in a world where negative rates are more commonplace, and creeping upward pressure on actual lending rates in Australia is likely to remain from higher funding costs and tighter capital requirements. 

Stay tuned.

Daniel.Gradwell is economist in ANZ's Australian Research unit and can be contacted here.

 

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