RBA on hold in November, 2020 growth and inflation forecasts unchanged: Bill Evans

EXPERT OBSERVER

The Reserve Bank Board meets on November 5 next week.

There is little chance that the Board will decide to cut the cash rate at that meeting.

Westpac confirms its forecast which was “refreshed” on July 24 that the Board would cut the rate by 25 basis points at the October meeting (done) and the February meeting in 2020.

Markets are pricing in a probability of a miniscule 4% for a November move.

However it was not always like that.

Back on October 4, I wrote, “we cannot concur with the markets pricing in a 50% probability of a follow up move in November".

There are a number of reasons for this caution.

Firstly, markets should understand that central banks will usually bias their comments on days on which they make policy changes to justify the decision. We saw some examples of that approach in the Governor’s Statement.

For example, he has, for no reason that is justified by the data, adopted a bolder objective than had been the case before by aiming for “full employment” rather than the more modest, “reduce unemployment” that we saw in September.

With the unemployment rate trending away from his full employment target and, by his own admission, "forward-looking indicators of labour demand indicate that employment growth is likely to slow from its recent fast rate" the introduction of that full employment target as a substitute for the more realistic “reduce unemployment” seems curious and is probably less significant than markets may have assessed.

We also think the RBA will be mindful of the response of the Westpac Melbourne Institute Consumer Sentiment Index to the consecutive cuts in June/July. Following the cut in July the Index fell by 4.1%. There was an apparent “spooking” of the consumer around the policy action.

With the RBA seeing the consumer as the key to the growth outlook, a “back to back” series of rate cuts leaving limited scope to cut further and risking a similar response from the consumer would counsel against that November move.”

Since that note we saw the Westpac MI Consumer Sentiment Index fall by 5.5% in response to the October rate cut, providing further evidence of the fragility of Confidence to low rates.
Under such circumstances consecutive rate cuts would seem to be a significant policy mistake.

Apart from the arguments I put forward on October 4 we have also seen an absence of downside surprises in both the Employment and Inflation reports with both the unemployment rate falling modestly from 5.3% to 5.2% and the trimmed mean annual inflation rate holding steady at 1.6%.

Looking further out, markets have turned against prospects for a December rate cut with probabilities falling from 80% back on October 4 to 25%.

We concur with that assessment but are surprised that market pricing for February has tumbled from 100% on October 4 to 50% today.

Read full report 'RBA on hold in November' (PDF 73kb)

BILL EVANS is the Chief Economist at Westpac