Australia & New Zealand Weekly: RBA Will Stick to Positive Forecasts but Risks are Mounting

Week beginning 5 November 2018

• RBA will stick to positive forecasts but risks are mounting.
• RBA: policy meeting, Statement on Monetary Policy.
• Australia: housing finance.
• NZ: RBNZ policy meeting, employment, wages, inflation expectations.
• China: trade balance, foreign reserves, CPI.
• Europe: Sentix investor confidence.
• US: FOMC meeting, mid-term elections.
• Key economic & financial forecasts.

Information contained in this report current as at 2 November 2018.

RBA Will Stick to Positive Forecasts but Risks are Mounting

The Reserve Bank Board meets next week on November 6.

The Bank will also release the November Statement on Monetary Policy on November 9.

Of course the Governor will announce that there has been no change in the cash rate.

Readers will be aware that Westpac adopted a “no change” call for both 2018 and 2019 back in September 2017. At that time markets were pricing in three hikes by end 2019.

Today, markets are pricing only the probability of around 50% of one hike by end 2019 and a full 25bps is not priced-in until end 2020.

Back in August this year, Westpac forecast that the cash rate would remain on hold in 2020.

So, while a year ago we were offering readers some forecasts that were significantly at odds with market pricing, our views today are now largely factored in by the market.

That does not mean that our views are universally supported. In the latest Bloomberg survey of economists’ forecasts, only 10 of the 24 forecasters expect the cash rate to be on hold (one is calling cuts) by end 2019. In addition, 9 of those 13 forecasters expecting rates to be rising expect multiple hikes. Note that the other three major Australian banks expect rate hikes next year.

So the case for rates on hold is certainly not a universally accepted one.

As usual we will scour the Governor’s statement next Tuesday for any hints towards a firmer tightening bias, but there is unlikely to be much to encourage these efforts.

The Statement’s themes will be the same: continuing global expansion; China slowing a little; international trade uncertainty; Australian growth to average a bit above 3% in 2018 and 2019; positive business conditions; household consumption a source of uncertainty; labour market outlook positive; wages growth low; but a gradual lift in wages growth expected; further gradual decline in the unemployment rate expected; inflation higher in 2019 and 2020; housing conditions in Sydney and Melbourne continue to ease; progress toward full employment and target inflation will be gradual.

The Statement on Monetary Policy will include an update of the Bank’s forecasts out to December 2020.

Forecasts for GDP growth are likely to be unchanged from the August Statement on Monetary Policy: 3.25% in 2018 and 2019; and 3% in 2020. These forecasts indicate above potential growth, which is generally accepted to be 2.75%.

Headline Inflation forecasts in August were 1.75% in 2018; 2.25% in 2019; and 2.25% in 2020.

With higher petrol prices than were expected in August, the RBA may raise its forecast for headline inflation in 2018 from 1.75% to 2%.

Underlying forecasts for inflation were 1.75% in 2018; 2% in 2019; and 2.25% in 2020.

These forecasts are likely to be unchanged.

On October 31, we received the Inflation Report for the September quarter of 2018. The key underlying measures would have disappointed the RBA. The annual pace of the average of the core measures further slowed to 1.7% from the 2.0% pace in the March quarter. The six month annualised pace of the core measures is now 1.5% – the slowest pace since September 2016. Recall that in May 2016, the then Governor Stevens was expecting 2.5% for core inflation through 2016 but revised that down to 1.5% following the release of the March quarter CPI. The Governor responded to that shock with a rate cut of 25 basis points in May and another in August.

At that time, the 6 month annualised pace of core inflation registered 1.4% through the March quarter and 1.2% through the June quarter. So momentum in inflation was indeed lower than current momentum but not by a significant margin. The longer the subdued 1.5% momentum continues, the harder it will be to justify the forecasts of 2% in 2019 and 2.25% in 2020.

One aspect of the detail within the September quarter 2018 CPI result that stood out was the sharp fall in the price pressures associated with house building. This component, which has the biggest weight in the CPI and consistently appears in the core measures, slowed from 0.8% in the June quarter to 0.1% in the September quarter.

We had a similar result for the March quarter in 2016 (0.2%) but the measure bounced back 0.9% in the June quarter as the housing market recovered through 2016 in response to the May and August rate cuts. Between March 2016 and December 2016 new lending to property investors lifted by 40% and house prices in Sydney (up 11%) and Melbourne (up 7%) both boomed in the last six months of 2016.

There will be no such recovery in 2018 or 2019. The RBA has made a clear commitment to holding the cash rate at the current level and bank lending policies continue to tighten and house prices in Sydney and Melbourne are likely to fall through 2019.

As a comparison with 2016, we note that new lending to investors has fallen by 27% over the last year and there is no sign of any relief.

It is entirely reasonable that builders in the process of constructing new residential developments in Sydney and Melbourne will find great difficulty in passing on cost increases as this particular component of the CPI has remained weak for many quarters. Supply is also likely to maintain downward pressure on rents which are another key component of the CPI. We would not expect the RBA to incorporate such concerns in their forecasts. They will continue to forecast rising inflation out to 2020 despite the risks around housing as well as the ongoing threat to inflationary expectations as the headline rate stays well below the 2.5% target (on a calendar year basis headline inflation has been below 2% since 2014).

The final forecast which appears in the SOMP will be for the unemployment rate.

The forecast in the August SOMP were for a gradual decline to 5.25% in December 2019 continuing to 5% in December 2020.

That was always a very awkward forecast for the RBA which is promoting the prospect of rising wage pressures particularly through 2019 and 2020.

For Australia, the “full employment” rate estimate is generally considered to be 5.0% but we have found that in other developed economies (particularly the US and UK) the full employment rate is lower in the current cycle than that historically. In the US, the unemployment rate has fallen to 3.7% (well below the previously accepted full employment rate of 4.75%) yet wage pressures are only just beginning to emerge, (the Employment Cost Index has lifted by 2.8% in the year to September).

It seems highly unlikely that in this current world of increasingly rapid technological change; globalisation; risk aversion of employees; low inflationary expectations and low trade union membership that Australia’s full employment rate is 5%.

With the current print (September) on the unemployment rate now at 5.0% (compared to 5.5% in the August SOMP) the RBA is expected to lower its 2020 unemployment forecast to 4.75%.

Note that the RBA use the three month average of the seasonally adjusted monthly unemployment rate estimate, which is currently 5.2%, as their latest read. That recognises the volatility in monthly estimates and the potential for the recent sharp fall in the unemployment rate to reverse somewhat over the next few months. Abstracting from the short-term particulars, the core profile of the forecast will be consistent with the key theme of a “gradual decline in the unemployment rate”.

In contrast, Westpac’s forecast reflects a likely slowdown in jobs growth in 2019 with the unemployment rate ticking up to 5.3% through 2019 before settling back at 5.0% by end year. In 2020 we would broadly concur with a 4.75% unemployment forecast by end 2020 although would not see that level as full employment.

Note that the August SOMP discussed the dynamic around the wealth effect as a risk but not a central theme driving the forecasts.

“Recent declines in national housing prices have been gradual and follow several years of very strong growth. Accordingly, there is no evidence that moderate housing price declines have weighed on household consumption to date. Nevertheless, housing assets account for around 55 per cent of total household assets, so lower housing prices could lead to lower consumption growth than is currently forecast. Although the earlier gains in national housing wealth may not have encouraged much additional consumption, it is possible that the consumption decisions of highly indebted and/or creditconstrained households could be more sensitive to declines in housing prices than to the previous increases.”

We expect this issue to remain a risk in the November SOMP but not a factor incorporated into the forecasts.

We view that risk as being much more likely and a central component behind our growth forecasts.

Westpac expects growth in 2019 to slow from 3.3% in 2018 to 2.75% in 2019.

The week that was

This week, inflation and the housing market have been in focus for Australia. Offshore, data for the US remained robust, but was less so in Europe and Emerging Asia.

Australian inflation has been an enduring disappointment for the market, with actual outcomes having come in below expectations quarter by quarter for close to two years. The September quarter continued this trend, with headline and the average of the core measures again sub-consensus at 0.4% (market 0.5%) and 0.3% (market 0.4%). More significant for policy, annual headline and core inflation again fell below the 2.0%yr lower bound of the RBA’s inflation range, now 1.9%yr and 1.7%yr. Within the quarter, there were many opposing influences, but the main theme was the offsetting of petrol and tobacco inflation by disinflation across house purchase costs and rents and the continued absence of pricing power for the retail sector. Though petrol will remain inflationary in coming months, persistent weakness in housing costs will limit the net effect for headline inflation. As the core measure typically omits energy costs, the effect here will be lopsided and result in annual core inflation holding below the RBA’s 2–3%yr target range through the end of 2019.

The soft housing inflation pulse is a consequence of declining house prices and rising supply (restricting rental growth). This week, the October CoreLogic house price data showed that this national decline in house prices is continuing. The decline is led by Sydney (–7.4%yr) and the top end of the market (the top 25% of sales by price down 7.7%yr versus –0.9%yr for the bottom 25%). However, we continue to see evidence of the weakness broadening, with 80% of dwellings now having seen price declines over the past six months compared to 60% for the past year. By dwelling type, losses remain largest for houses.

Dwelling approvals data for September was also released this week. While a bounce was seen in the month, approvals are still down 14% over the year. Further, if high-rise approvals in Victoria are omitted, we estimate approvals actually fell 7.5% in September, with the weakness broad-based by state and dwelling type. Given this trend decline in prices and approvals, it is unsurprising that housing credit growth continues to decelerate. In 3-month annualised terms, total housing credit has slowed from 6.8% in May 2017 to 4.7% currently. Though investor credit has been the primary driver of this softening, owner-occupier credit has also slowed, from 8.7% in July 2017 to 6.4% currently.

Turning to the US, GDP was again strong in the September quarter at 3.5% annualised. Driving the result was a willing consumer, with growth in this sub-sector rising 4.0% annualised. Elsewhere however, there were a number of signs that higher interest rates are taking effect. This was most obvious in residential construction, now down around 3% annualised over the past nine months, while there are glimpses of weakness in business investment following a strong start to the year. For growth to persist at an above-trend pace, consumption must continue to fire. On this front, the upside surprise for the employment cost index in the third quarter, a 0.8% gain for total compensation, was promising. That said, annual income growth still remains relatively modest at 2.8%yr. To sustain the current pace of consumption, quarterly gains nearer 1.0% are needed. We are not convinced this will occur. If consumption does slow, then together with a softening pulse for business investment and the loss of extraordinary support from fiscal policy (in late 2019), US growth will slow back to trend during 2019.

While debate over the US economy remains focused on whether growth will be at or above trend, for Europe the risk of sub-trend growth is building. The first estimate for the September quarter has disappointed, coming in at just 0.8% annualised, below our estimate of trend growth, 1.2%yr. One-off factors were reportedly at play in the most recent three months, so more time is arguably needed to assess the trend. Looking forward, domestic political risks are paramount. This week, the source of uncertainty was in Germany with Chancellor Merkel announcing that she will not contest her CDU Party leadership this December but remain as Chancellor until the end of the Coalition’s term in 2021, but will not stand for re-election.

In the UK, the Brexit deadline grows nearer. With those clouds up ahead, the BoE left rates on hold this week while retaining their gradual tightening bias. The economy is described as “broadly in balance” with the domestic labour market tight and wages growth picking up more than expected. Indeed, if it were not for Brexit uncertainty, the Bank rate would be higher.

Finally to Asia, there we have seen moderating global growth and US trade policy continue to weigh on the manufacturing sector of China and other east Asian nations. For China in particular, domestic demand remains a positive, aided of late by stabilising investment but the downtrend in employment growth poses a risk. This highlights why authorities are becoming more active in the management of the domestic economy and US’ tariffs effect on China’s external competitiveness.

Chart of the week: Australia Q3 nominal and real retail sales

The September retail report was on the soft side, monthly sales coming in a touch under expectations, the quarterly gain in real retail sales also below expectations and the previous quarter’s strong gain pared back. While some of this reflected a stronger than expected price gain, there was a fair bit of evidence in the survey detail suggesting that discretionary spending is slowing and hints that the turnaround in housing markets in Sydney and Melbourne may be starting to affect demand.

Monthly sales rose 0.2%, a touch short of the consensus forecast of 0.3% but in line with Westpac’s view.

However, sales volumes for the quarter were more underdone, rising 0.2% vs consensus and Westpac forecasts of a 0.4% gain and with Q2’s strong 1.2% gain revised back to a 1% increase.

New Zealand: week ahead & data wrap

Financial media in New Zealand has been abuzz with stories of falling equity prices in the US, and falling house prices in parts of Australia. The implication is that New Zealand will be affected – an idea that is far too simplistic.

There will be very little direct impact on the New Zealand economy from either falling US share prices or falling Australian house prices. New Zealanders are not big owners of Australian property, international equities, or even New Zealand equities, so there won’t be much in the way of a wealth effect. We’ve seen claims that New Zealand house prices tend to follow Australia’s, but these are simply untrue – the two countries often experience distinct housing cycles. When we prepare our forecast of New Zealand GDP growth for our next Quarterly Economic Overview, neither US equity prices nor Australian house prices will be major factors in our thinking.

That said, what is happening in the US and Australia does serve as a warning of sorts for New Zealand. It is probable that in the future New Zealand will suffer parallel situations for parallel reasons.

In the United States, the strong economy is generating fears of inflation, and consequent fears of higher interest rates. When interest rates rise, investors tend to find bonds more attractive. Consequently, they demand a higher rate of return before investing in equities – which can only be achieved by paying a lower price in the first place. Share prices in the US have been weaker this year mainly due to rising interest rates.

The parallel for New Zealand would be house and farm prices falling when local interest rates eventually rise. The key reason that New Zealand house and farm prices have risen in recent years is record-low mortgage rates, which made it cheaper to borrow and made other forms of saving, such as term deposits, less attractive. Our analysis suggests that when New Zealand interest rates rise, house and farm prices will fall.

That would certainly be serious for the New Zealand economy. Kiwis have an extremely high proportion of their wealth tied up in houses and farms, and tend to consume less when the prices of those assets fall. A house and farm price downturn would also hit the economy via the banking system. A high proportion of bank loans in New Zealand are secured over property. When banks see their security buffers eroding, they tend to become less keen to lend to productive parts of the economy, which crimps growth.

But any likelihood of rising interest rates impacting New Zealand asset prices is years away, and is not a factor in the very nearterm outlook. In fact, New Zealand recently experienced a drop in fixed mortgage rates which we expect will boost house prices in the immediate future.

Declining house prices in parts of Australia have been more to do with regulation. Bank lending standards have tightened at the regulator’s behest. This has reduced households’ access to credit, leaving them less able to pay for property. At the same time, changing rules are making it more difficult for foreign buyers to purchase property in Australia. Together, these two factors have been important drivers of Australia’s housing market downturn. New Zealand’s housing market could well be affected by similar drivers in the future. New Zealand has recently introduced a foreign buyer ban. That probably is an imminent negative for New Zealand’s housing market, and will suppress Auckland house prices in particular.

New Zealand could be affected by Australia’s tighter banking regulations, because the biggest New Zealand banks are all wholly owned subsidiaries of Australian parents. But we are expecting the Reserve Bank of New Zealand to loosen its LVR mortgage lending restrictions when it delivers its next Financial Stability Report on 28 November. New Zealand banks could soon be loosening their lending standards, not tightening them. So credit conditions are more likely to boost the housing market in the near term, rather than constrain it.

A third factor affecting Australia’s housing market has been a lift in mortgage rates independent of the Reserve Bank of Australia. This followed a lift in funding costs for Australia’s banks. Again, New Zealand is currently experiencing falling mortgage rates, not rising. New Zealand has not experienced a lift in bank funding costs to anything like the same degree as Australia. So while this is something for New Zealand to watch, it is not a factor in the immediate outlook.

Weighing the near-term positives against the near-term negatives, we remain very comfortable with our view that New Zealand’s housing market and economy will pick up a little in the very near term. However, further in the future we do expect an extended episode of falling house prices that will crimp consumer spending and therefore slow the economy. Rising mortgage rates and changing tax policy will eventually come to bear on house prices. But that expected downturn will be for local reasons and on New Zealand’s own timetable, not simply because we are destined to follow other countries.

Next week will be critical for financial markets. We expect the September quarter labour market surveys, released on Wednesday, to register another small rise in unemployment, from 4.5% to 4.6%. The labour market is cooling a little following the economic slowdown that occurred over 2017.

The following day, the Reserve Bank will release its November Monetary Policy Statement. We expect the Reserve Bank to acknowledge the recent run of strong economic and inflation data in the detail of the document, and by lifting the OCR forecast slightly. However, we expect the RBNZ to stick to the same broad outlook for monetary policy, including retaining the key line that the next move in the OCR could be “up or down.” Such a “slightly hawkish” Statement would produce only a minor upward move in swap rates and the NZD.

Data Previews

Aus Nov RBA policy decision

• Nov 6, Last: 1.50%, WBC f/c: 1.50%
• Mkt f/c: 1.50%, Range: 1.50% to 1.50%

The RBA will again hold rates unchanged at their November meeting, as they have since they last cut rates in August 2016. The Governor’s decision statement will repeat the line that: “further progress in reducing unemployment and having inflation return to target is expected, although this progress is likely to be gradual”. We expect the RBA cash rate to remain unchanged at 1.50% throughout 2018, 2019, and during 2020.

This month’s decision will be followed by the release of updated commentary and forecasts with the RBA’s Statement on Monetary Policy on Nov 9. We expect the Bank to retain its upbeat 3.25% growth forecasts for both 2018 and 2019 with no change to its trajectory for inflation. But a lower starting point is likely to lower the forecast profile for the unemployment rate. See p2 for more detail.

Aus Sep housing finance (no.)

• Nov 9, Last: –2.1%, WBC f/c: –1.0%
• Mkt f/c: -1.0%, Range: -2.2% to 0.5%

Housing finance approvals continued to soften in August. The headline number of owner occupier loans fell 2.1% to be down -10.2%yr. The value of investor loans was also lower, down 1.1% to be 20.5% lower over the year (an estimated -26% ex refi).

The September update is likely to be another weak one. Housing markets continued to correct in the month, auction clearance rates again moving lower and prices slipping across all major cities. Industry data points to a 1% dip in the number of finance approvals with a more substantive fall in the value of approvals suggesting a significant reduction in average loan size, in turn reflecting a reduction in assessments of borrowing capacity. The value of investor loans will again be of interest.

NZ Q3 Household Labour Force Survey

• Nov 7, Employment change, Last: +0.5%, WBC f/c: 0.5% Mkt f/c: 0.5%, Range: 0.3% to 0.7%
• Unemployment rate, Last: 4.5%, WBC f/c: 4.6% Mkt f/c: 4.5%, Range: 4.4% to 4.6%

We expect the September quarter survey to show a small rise in the unemployment rate for the second quarter in a row. A modest 0.5% rise in employment would see annual growth slow to 2%.

Recent indicators of labour demand have been mixed. Business confidence surveys have shown a sharp drop in hiring intentions, but job advertisements have continued to grow, albeit at a slower pace.

A rise in the unemployment rate would be unwelcome for the Reserve Bank, given its recently-added focus on maximum sustainable employment. However, there will be little time to consider the results before the Monetary Policy Statement.

NZ Q3 Labour Cost Index

• Nov 7, Private sector last: 0.6%, WBC f/c: 0.6%
• Mkt f/c: 0.5%, Range: 0.4% to 0.7%

We are expecting a 0.6% rise in the Labour Cost Index for all sectors, with private sector growth of 0.6%. In both cases this amounts to annual growth of 2%.

Wage growth this quarter will be boosted by the first stage of the nurses’ pay agreement, with a 6% increase that covers about 1% of the total workforce. We’ll also see the second stage of the pay equity settlement for aged care workers, though the impact is much smaller than in the first stage a year ago.

The June quarter survey showed early signs of a pickup in private sector wage growth. However, the LCI tends to evolve very slowly, which makes it difficult to judge whether there has been a genuine change in the trend.

NZ Q3 RBNZ survey of inflation expectations

• Nov 7, Two years ahead, last: 2.04%

Since the last RBNZ survey of expectations, we’ve seen GDP growth surprising to the upside, a larger than expected increase in consumer price inflation and widespread public attention on petrol prices. More generally, businesses are highlighting upside pressure on prices and costs.

The RBNZ’s two year ahead inflation expectations measure (the most closely watched of the gauges the RBNZ puts out) tends to be more stable than other measures of expectations due to its longer-term focus. However, with signs of growing pressure on costs and other positive data in recent months, the risks are tilted towards at least some increase.

NZ RBNZ Official Cash Rate and Monetary Policy Statement

• Nov 8, Last 1.75%, WBC f/c: 1.75%, Mkt: 1.75%

We expect the RBNZ will leave the OCR on hold at 1.75% at its November meeting. However, as activity and inflation developments have been stronger than the RBNZ expected, the accompanying policy statement will be at least a little more hawkish than the August missive (though any change will be minor and will be confined to the details of the document).

We expect the RBNZ to stick to the same broad monetary policy outlook, including restating the all-important phrase that the next move in the OCR could be “up or down” and that it “intends to keep the OCR at an expansionary level for a considerable period.”

The RBNZ’s August OCR forecast was flat at 1.8%, before starting to rise in September 2020. That putative date for OCR rises could be brought forward by one or two quarters.

NZ Oct retail card spending

• Nov 9, Last: +1.1%, WBC f/c: +0.5%

Retail spending levels rose by a solid 1.1% in September, following a similar sized gain in August. Those gains were underpinned by increased spending on consumables (e.g. groceries), as well as firm spending on durables. Spending levels have been boosted by the Government’s Families Package, which has added to the disposable incomes of many households.

We expect more modest spending growth in October and are forecasting a 0.5% gain in the month. While the lift in disposable incomes has added to the level of spending, higher fuel prices are limiting increases in discretionary expenditure in core categories.

US November FOMC meeting

• Nov 7-8, last 2.125%, WBC 2.125%

The FOMC has persistently focused on the US’ own real economy in 2018. As a result, their belief in a continued ‘gradual normalisation’ of monetary policy has remained resolute.

Come the November meeting, there is no reason to expect a material change in view, though rates will not be raised. Employment growth has remained strong, so too GDP.

The nascent evidence of interest rate sensitive sectors coming under pressure is unlikely to concern the Committee at this stage with policy still seen as accommodative. This is also true of recent market declines as equities remain at elevated levels.

For the FOMC, next week’s mid-terms have little to no immediate significance. Fiscal policy will become an issue from mid-to-late 2019, as support for growth fades.