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Australia & New Zealand Weekly: Why RBA Will Keep Rates on Hold

Week beginning 28 January 2019

  • Australia: CPI, private credit, trade prices, CoreLogic home prices, Australia Day.
  • NZ: trade balance, Auckland Anniversary Day.
  • China: NBS and Caixin PMI’s.
  • Euro Area: CPI, GDP, unemployment, ECB President Draghi speaks.
  • UK: BOE Governor Carney speaks
  • US: FOMC meeting, non-farm payrolls, (GDP and PCE releases likely to be delayed due to shutdown).
  • Key economic & financial forecasts.

Information contained in this report current as at 25 January 2019.

Why the RBA will keep rates on hold; next Fed hike delayed to June due to shutdown

After the usual summer recess the Reserve Bank will conduct its Board meeting on February 5, followed by a speech from Governor Lowe on February 6 and the February Statement on Monetary Policy which will print on February 8.

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Of course there will be no rate change following the Board meeting but there will be considerable interest in the Governor’s Statement and the subsequent communications.

Recall that the minutes of board meetings have usually contained words along the lines of “members continued to agree that the next move in the cash rate was more likely to be an increase rather than a decrease.” Alternatively the November Statement on Monetary Policy noted “further reducing unemployment and ensuring inflation is consistent with the target. If that progress is made higher interest rates are likely to be appropriate at some point.”

But those sentiments were expressed when markets had been anticipating rate hikes. At the beginning of 2018 when Westpac was predicting the cash rate would remain on hold in both 2018 and 2019, markets had priced-in a full 25bps rate hike by end 2018. Today, markets are assessing that the next move in the cash rate will be down by 25 basis points with a probability of 60% (13bps) by year’s end.

In defence of the economists, only 11 of the 20 forecasters (Bloomberg Survey, January 12, 2018) predicted a hike or hikes in 2018 but this group did include the other three major banks, AMP, and most major investment banks.

There is no survey evidence to check how many of the “nochange nine” supported the Westpac view that rates would remain on hold through 2019 as well.

There is also, at this stage, little support from the economists for the “market view” that rates will be cut by end 2019. Since that survey in January last year Westpac has extended its “on hold view” through 2020.

The key as to whether the Reserve Bank will placate markets and adopt a pure neutral bias by eliminating the “next move up” in its commentary will hinge on how it reassesses its forecasts which will be released with the February Statement on Monetary Policy which prints on February 8.

Recall that, based on its forecasts in the November SOMP, the conclusion that the cash rate would eventually rise was reasonable.

Growth was forecast at 3.5% in 2018; 3.25% in 2019; and 3% in 2020.

Trend growth is assessed by the RBA as 2.75% (1 ppt for productivity growth and 1.75 ppt’s for labour force growth).

Three consecutive years of comfortably above trend growth could be expected to erode significant excess capacity and boost employment growth so that inflation would lift into the 2-3% target range and the unemployment rate would approach the NAIRU.

Accordingly, the Bank forecast core inflation to lift to 2.25% in 2019 and 2020 and the unemployment rate to fall to 4.75% by end 2020.

Their views on the labour market have been cautious. The unemployment rate has already reached 5% while the Wage Price Index growth rate has lifted in recent quarters to 2.3%. Scrutiny of a chart which, for the first time, was provided in the November SOMP points to a cautious forecast of WPI annual growth reaching 2 ½ per cent by end 2020.

But the September quarter GDP report has disrupted the RBA’s comfortable position. With growth only printing 0.3% in that quarter it would be necessary for Q4 to print 1.2% to achieve the November forecast of 3.5%.

The 2018 growth forecast is likely to be lowered from 3.5% to 3.0%. But what will this mean for the 2019 and 2020 growth forecasts?

We know that the Bank has assessed a minimal wealth effect on consumption and the Q3 growth report is unlikely to have changed that view. Even further negative evidence on house prices in Sydney and Melbourne is unlikely to change the qualitative assessment that the wealth effect was minimal while house prices were booming and therefore will be minimal in reverse.

Westpac differs in that regard pointing to a fall in the savings rates in NSW and Victoria over the year to September 2018 of 1.7 ppt’s. We expect some reversal of that effect in 2019 and 2020 pushing growth in consumer spending down from our previous forecast of 2.6% in each year to 2.4%.

We expect the Bank will maintain its current view that consumer spending will run at a growth rate of 3% in both 2019 and 2010. We also differ on the likely downtrend in residential construction in 2019 and to a lesser extent in 2020, “Dwelling investment has remained high and… should remain at a high level for the next year or so” (Nov SOMP).

Westpac’s growth forecasts are 2.6% in 2019 and 2.6% in 2020. Those forecasts are only slightly below trend and consistent with steady rates in 2019 and 2020.

We expect the RBA will forecast growth of 3% in 2019 and 3% in 2020. That higher growth will reflect a limited slowdown in housing construction and no meaningful wealth effect. Those growth forecasts are still above trend and likely to ensure the view that the next move in rates will be up.

If we thought the RBA was likely to lower its growth forecasts in 2019 and 2020 to 2.5% or less then we would certainly expect it to adopt an easing bias .

If a central bank expects below trend growth, particularly in the “pol