RBA will hold: Westpac's Bill Evans
The Reserve Bank Board meets on August 4. We expect the Board will decide to keep rates on hold.
Markets are in full agreement with this view with only a negligible probability of a rate cut being priced in.
It is a different story for November with market pricing oscillating between 60% and 80% probability of a cut by then.
With this in mind, attention will focus on the Governor’s decision statement, released at 2:30pm on August 4, and the Statement on Monetary Policy which will print at 11.30am on August 7.
We are not expecting any surprises in the Governor’ statement. He has finally found the right approach to ‘talking down’ the Australian dollar with the language:
“Further depreciation seems both likely AND necessary, particularly given the significant declines in commodity prices”. He first used that sentence in May when the AUD was around USD 0.787; followed up in June (USD 0.7682) and then in July (USD 0.744).
Now at USD 0.73 the AUD has certainly not fallen sufficiently for the Governor to abandon a successful strategy. Further, we suspect that the key reason behind his referring to potential further easing (“We remain open to the possibilities of further easing if that is, on balance, beneficial for sustainable growth”) in speeches is also a desire to maintain downward pressure on the Australian dollar.
The forecasts for growth and inflation presented in the Statement on Monetary Policy will be of critical interest.
Recall that in February this year the Bank adopted an approach of assuming ‘market pricing’ for the cash rate profile. At the time the market had a near 100% probability of a further rate cut by June to complement the cut in February. Markets could be excused
for interpreting that change of approach as, in effect, franking its pricing for another rate cut. The Bank repeated the approach in its May Statement on Monetary Policy, when market pricing only had a 40% probability of a follow-up cut by year’s end price in – not a high enough probability to encourage speculation.
Next week, with markets pricing in a 65% probability of a further rate cut by year’s end and an 80% probably of a move by early next year, considerable attention will be given to whether the assumption of market pricing is retained. I expect that for the purposes of continuity the Bank will retain the market pricing assumption but would not interpret this as any kind of signal.
On the other hand, if the Bank drops that assumption, it would be a most discouraging signal for those folks expecting a near term rate cut.
Note that in the May Statement on Monetary Policy the Bank forecast that underlying inflation would centre around 2.25% in 2016. Apart from during the depths of concerns around the Global Financial Crisis in 2009, this is the first time since the Bank started publishing forecasts that it has forecast underlying inflation to be below than the midpoint of the target range in the next calendar year.
This is surely a very dovish signal from the authorities. Even though the AUD has fallen from USD 0.80 (the assumption used for its inflation and growth forecasts in May) to USD 0.73 I expect that the Bank will retain its dovish inflation forecast.
The other risk is around the Bank’s assessment of trend growth.
As discussed in last week’s note the Governor indicated that the Bank would be reviewing its assumption of trend growth, which has generally been assessed as 3–3.25%.
Australia has been consistently growing below that pace since the GFC. The assessed negative output gap has weighed on inflation. If however, the trend growth rate was, say, 2.75% then the negative output gap would be smaller and disinflationary pressures less intense. Theoretically, all else being equal, that would imply a need to raise the inflation forecasts.
We expect that the Bank may make that adjustment in future but not in the next Statement on Monetary Policy.
Recall that the growth forecasts are currently 2.5% for 2015 and 3.25% for 2016, down from 2.75% and 3.5% respectively in the February Statement.
Since May the data releases around the real economy have generally been disappointing. In particular the March quarter national accounts and the March quarter Capex survey have revealed a weaker than expected investment profile for both mining and non-mining and no evidence of a recovery in the downbeat 2.5% annualised pace of consumer spending.
The ‘sticker shock’ effect of further lowering the 2015 forecast seems too high to consider but it does seem likely that the growth forecast for 2016 will be reduced to 3%.
Policy will be targeted on growth in 2016. At 3%, growth would still be assessed at ‘around’ current estimates of trend and would still be consistent with no policy change.
However, markets might seize on the disturbing downtrend in the 2016 growth forecasts and speculate on a ‘below trend’ forecast for 2016 in the November Statement on Monetary Policy.
That would not be a good strategy.
By then the Bank is likely to have adopted a lower trend growth assumption (say 2.5–2.75%). Even with a further downward revision to the growth forecast in 2016, from 3% to 2.75%, this would still be at or above the newly assessed trend precluding the need for a policy response.
BILL EVANS is chief economist of Westpac.