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Australia & New Zealand Weekly: RBA Cash Rate to Remain on Hold in 2020

Week beginning 27 August 2018

  • Westpac extends forecast to 2020 – RBA cash rate to remain on hold in 2020.
  • Australia: dwelling approvals, capex, credit.
  • NZ: residential building consents, business confidence.
  • China: official NBS PMI’s.
  • Europe: CPI, employment, ECB Chief Economist Praet speaks.
  • US: PCE inflation.
  • Key economic & financial forecasts.

Information contained in this report current as at 24 August 2018.

Westpac extends forecasts to end 2020 – RBA cash rate to remain on hold in 2020

To date Westpac has issued public forecasts for the outlook for growth and financial markets to March 2020.

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These forecasts are incorporated in the August Market Outlook publication.

We are now extending those forecasts to end 2020.

Last year around this time we surprised markets by forecasting no change in the RBA cash rate out to end 2019. At the time markets were priced for at least three rate hikes (25 basis points per move) and the overwhelming majority of forecasters were anticipating the rate hike cycle to begin in 2018.

Markets have now partly moved into line with our view with only around a 50% probability of one rate hike by the end of 2019. Furthermore, 65% of forecasters in the Bloomberg survey are still expecting the cycle to begin by the third quarter of 2019.

Our view is that the cash rate is likely to remain on hold not only through 2018 and 2019 but also 2020.

Some may argue that we are unrealistically forecasting that Australia will completely miss the global rate hike cycle if rates remain on hold for such an extended period.

We differ from that view arguing that financial conditions are affected by more forces than just the RBA cash rate.

Through 2017 and 2018 we are already observing tightening conditions in the absence of RBA rate hikes.

This tightening is emanating from heightened macroprudential policies from the banking regulator APRA and the rise in wholesale funding costs for banks and corporates.

New lending to housing investors has fallen by 25% over the last year; housing credit growth is likely to slow from 6.5% in the year to September 2017 to 4% in 2018/19 and 2019/20. The bank bill rate has “settled” at around 25 basis points above those levels, which prevailed in previous years and is priced in markets to remain there for at least the next year or so.

As a direct reflection of that tightening in financial conditions we are now seeing housing markets weakening with outright price falls in both Sydney and Melbourne.

These price corrections look set to be sustained for at least the remainder of 2018 and 2019 with soggy markets likely prevailing through 2020.

Housing markets typically recover when there is an increase in new buyers in the market. That increase can be attributed to a boost in affordability or a rise in confidence.

In previous cycles affordability has been boosted by multiple rate cuts from the Reserve Bank; lower prices; and rising incomes.

In this cycle the Reserve Bank has made it clear that short of a major global financial shock (most likely emanating from China) or a major collapse in the local housing market, it will resist cutting the cash rate.

Neither of those scenarios figure in our central case.

Furthermore, we do not envisage a marked lift in income growth over the forecast period. Accordingly the “responsibility” for the restoration of affordability in the two major housing markets will accrue to prices. So an extended period of price weakness is required before we return to levels of affordability that will attract new buyers and stabilise the markets.

Confidence will also be a factor that will discourage new entrants over the 2019 period as the economy deals with uncertainty around the electoral process. In that regard the parties have significant differences regarding tax policies for property investors.

The global environment through 2019 and 2020 will not signal any need to further tighten financial conditions. We expect that the US economy will be slowing through the second half of 2019 and through 2020. We currently anticipate that the Federal Reserve will go on hold in the second half of 2019.

The risk to this scenario is a sharper increase in inflation in 2018 and 2019 as the US economy deals with the “cocktail” of an unemployment rate well below full employment and a strong fiscal stimulus. This would result in a larger and longer tightening cycle through 2019 to be followed by an even sharper slowdown in 2020.

China has signalled its commitment to reduce leverage. This is likely to be a sustained commitment through 2018; 2019; and 2020 as the authorities grapple with the need to diffuse the distortionary impact of the largely unregulated shadow banking system.

As we have seen in recent weeks the authorities will have no patience for a sudden slowdown in growth (likely precipitated by the reduced leverage and the concerns around trade wars). However the authorities are still expected to accept a gradual slowing to a