No surprise the RBA cut: Westpac economist Bill Evans

No surprise the RBA cut: Westpac economist Bill Evans
No surprise the RBA cut: Westpac economist Bill Evans

As expected the Board of the Reserve Bank decided to lower the cash rate by 25bps to 1.5% at its August Board meeting.

The key final paragraph which indicated the Board had no bias: “Taking all these considerations into account, the Board judged that prospects for sustainable growth in the economy, with inflation returning to target over time, would be improved by easing monetary policy at this meeting.”.

This is not surprising since the same policy approach was taken following the May meeting when the Board also cut by 25bps.

It is worth recalling that no bias was indicated at the following June meeting but was restored at the July meeting with a cut in August following.

Consequently, this decision to exclude a bias should not be seen as ruling out another move at the next ‘live’ meeting in November.

As we have been indicating to our customers the key factor behind the cut was low inflation.

In May, the Bank lowered its underlying inflation forecast for 2016 from 2.5% to 1.5% and lowered its forecast for 2017 from 2.5% to 2%.

These sharp changes, for an inflation targeting central bank, were extremely significant and certainly laid the foundation for today’s move.

Not surprisingly, therefore, the commentary around inflation remained downbeat with recent data confirming low inflation and the outlook being for low cost pressures remaining the case for some time.

The most fertile debate around prospects for this meeting centred on housing.

There was some private sector data that indicated that house prices had responded sharply to the May rate cut, potentially posing a risk to today’s decision.

The Governor’s statement has dedicated a particularly long paragraph to the housing market.

In July house prices were described as having “risen again in many parts of the country in recent months”.

However, in today’s statement, he is more downbeat, commenting that: “dwelling prices have been rising only moderately over the course of this year”.

He also notes that the pace of lending for housing has slowed this year. Finally he concludes that “the likelihood of lower interest rates exacerbating risks in the housing market has diminished”. We can conclude from this paragraph that the Bank sees limited risk from the rate cut to a resurgence in house prices.

Commentary on the exchange rate remains the same as last month with “an appreciating exchange rate could complicate this [rebalancing in the economy]”.  So there has been no attempt to talk down the currency with the power of lower rates doing the real job.

Confirmation that the recent slowdown in jobs growth has affected the Board’s thinking comes with the labour market indicators continuing to be described as “mixed … but consistent with a modest pace of expansion in employment”.

There is no explicit clarification as to whether this modest pace will be sufficient to further bring down the unemployment rate. We will get a better indication of the Bank’s likely revised outlook for the unemployment rate in the Statement on Monetary Policy on Friday.

Internationally the focus continues on China with an additional comment that “the underlying pace of China’s growth appears to be moderating”.

The outlook

Since the RBA surprised us with the May rate cut we had expected a follow up move in August.

When we saw the dimension of its inflation forecast changes that follow up move became even more likely.

The only barrier to such a decision was going to be the June quarter inflation report which would provide evidence as to whether the Bank had over-reacted to the shock in the March quarter report. While the June quarter report indicated that inflation was not as weak as in March it still confirmed that most of the disinflationary pressures apparent in March had persisted.

Our current view is that a further cut in November is not likely. With interest rates very close to their effective floor we expect that the Bank will be very patient in gathering information around the likely growth and inflation outlook. From our perspective the near term prospects for the real economy appear to be encouraging with lead indicators for the labour market improving and the lift from housing construction and services exports being sustained.

For us the real issue will be the environment in 2017 when the housing cycle will be in reverse; jobs growth may have cooled; global growth, particularly in this region, will have slowed further; and Australia’s interest rates may still be attractive to international investors. It is likely that any change in our current forecast that rates have bottomed will have been motivated by clearer prospects of those developments.Wee expect that the RBA will be similarly cautious with their assessment.

It is a little early to draw those conclusions given the unusually high degree of uncertainty, particularly around the global environment, but suffice to say that the risks to the rate outlook, particularly in 2017, are firmly to the downside. 

 

BILL EVANS is chief economist of WestpacJustin Smirk is ‎senior economist, Westpac Group and can be contacted here.

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