Australia & New Zealand Weekly: Federal Budget Unlikely to Deter RBA from Shifting to an Easing Bias in May

Fundamental analysis of Forex market

Week beginning 8 April 2019

  • Federal Budget unlikely to deter RBA from shifting to an easing bias in May.
  • RBA: Deputy Governor Debelle speaks, Financial Stability Review.
  • Australia: Westpac-MI Consumer Sentiment, housing finance.
  • NZ: REINZ house sales and prices, retail card spending.
  • China: trade balance, CPI, new loans.
  • Europe: ECB meeting, EU summit on Brexit.
  • US: CPI, FOMC minutes.
  • Key economic & financial forecasts.

Information contained in this report current as at 5 April 2019.

Federal Budget Unlikely to Deter RBA from Shifting to an Easing Bias in May

On Tuesday we noted a significant change in the Statement by the Reserve Bank Governor:

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“Our research showed that there has been a very significant change in the Governor’s Statement for this month. Recall that Governor Lowe has not changed monetary policy since he became Governor in September 2016. Also note that the key concluding sentence, which has been used in every Statement since October 2016 has been “the Board judged that holding the stance of monetary policy unchanged at this meeting would be consistent with sustainable growth in the economy and achieving the inflation target over time”. The clear implication behind that statement is an expectation that policy was likely to be on hold for a considerable period. As we have seen, that was an accurate assessment.

In the April Statement, he has changed that language for the first time ever. He still notes that “the Board judged that it was appropriate to hold the stance of policy unchanged at this meeting”. However, he then changes tact with a new sentence.

“The Board will continue to monitor developments and set monetary policy to support sustainable growth in the economy and achieve the inflation target over time”. Although, a cursory glance at this sentence might not indicate any change in stance, it does give greater emphasis to the fluidity of the current situation. If this change was not intended, then clearly he would have continued with the approach that has marked his time as Governor.

Therefore this change appears to be a very clear intention to signal that policy is much more ‘live’ than has been the case since the Governor was appointed.

This signal is consistent with Westpac’s expectation that the Board is likely to adopt an easing bias following the May Board meeting. Our thinking behind that approach has been that the Statement on Monetary Policy for May will include a downward revision of the Bank’s growth forecasts. Further support for this view is apparent in the exclusion of the RBA’s current growth forecasts in the April Governor’s Statement. Arguably, this indicates an uneasiness with the 3 per cent for 2019 and the 2¾ per cent for 2020.”

This Statement was released before the announcement later in the day of the Federal Budget.

In our note last week, “What impact will the Federal Budget have on monetary Policy” we calculated that the Government would have up to $3bn for a potential cash payout in 2018/19. We also estimated scope in 2019/20 for a spending boost of $7.5bn ($2.5bn from MYEFO’s “allocated but not announced” and $5bn from an improved Budget position in 2019/20). That equates to 0.15% of GDP in 2018/19 and 0.37% in 2019/20.

Ultimately, the announcement of the Budget came in a little less compared to our expectation with net new spending decided at $5.5bn in 2019/20 – 0.27% of GDP.

Given the current headwinds facing the consumer of weak income growth and a negative wealth effect, the most significant issue pertaining to monetary policy decision making is any immediate boost for the household sector.

In that respect, the hallmark spending initiative of the Budget is an expansion to last year’s Personal Income Tax Plan. The additional tax cuts will amount to $19.5bn over the four year forward estimate period to 2022/23, but an already $13.8bn had been put aside in MYEFO.

It’s worth remembering $8.6bn of the $19.5bn personal income tax cut plan expansion does not occur until the final year of 2022/23. In the near-term, the Low and Middle Income Tax Offset (LMITO) will put only $3.5bn (0.27% of disposable income) in consumers’ pockets in 2019/20 when they file their 2018/19 tax returns. Measures included in Budget 2018 offer households a further benefit of $3.8bn (0.29% of disposable income) impacting in the 2019/20 year, though this is funded by other measures, primarily combatting illicit tobacco use.

In Bill Shorten’s budget reply, he offered a higher LMITO – the base increased to $350 from $255 and the maximum benefit kept at $1080 – but it only adds an extra $1bn over four years.

So in any case, we believe this income boost is not large enough to offset falling house prices, low wages growth, rising savings rates and softening global growth.

In regards to any Budget “cash splash”, the result was a decidedly underwhelming total payment in 2018/19 of $360mn. The programme sees payments of $125 per couple (pensioners and others) and $75 per individual, and has now been extended to Newstart recipients. That compares with $500 offered by the Howard government in 2007, to a strong economy where there was little justification for a ‘splash’.

Overall, new measures aside, we need to keep the big picture in mind – the Budget is shifting from a deficit of $4.2bn to a surplus of $7.1bn. Using the aggregate individual tax intake and our disposable income growth forecast of 4.0% in 2019/20, personal income tax as a share of disposable income declines to 17.9% in 2019/20 from 18.1% in 2018/19 – a decrease, but only a modest one.

In assessing any immediate impact to consumer spending, the total LMITO directly amounts to 0.6% of annual household disposable income in 2019/20. The refunds will likely be received early in 2019/20 for last year’s tax returns and are skewed towards low to middle income households who typically have a higher marginal propensity to consume.

However, as our Westpac-MI Consumer Sentiment survey deteriorated in March to its lowest level since September 2017, we believe the consumer will be cautious, corresponding to a relatively low spending rate of the tax cuts which limits the overall impact. Our post Budget survey released on 10 April will be important to assess if the mood has changed.

Outside of these direct initiatives for household incomes in the coming financial year, other major new spending programmes centre on infrastructure and health. While we acknowledge this will provide much needed services for a growing population, in assessing the immediate impact on the economy, their effect is protracted and will have a more minor influence on 2019/20.

The upcoming Federal election – reportedly set to take place on May 11 – represents an unknown given the potential for a bidding war to emerge. Major changes to announced policy by the government would appear unlikely and the RBA is likely to see any bidding war as a temporary “sugar hit” that will not generate sustained higher income growth. The RBA is also likely to look through the near-term personal income tax relief and cash payouts for energy bills.

As such, Westpac sees fiscal policy as having only a modest impact in the near term and continues to expect cash rate cuts in August and November to cushion the economy against the headwinds of 2019.

The week that was

Fiscal policy came to the fore this week in Australia, as Budget 2019 and the opposition’s reply were delivered. Offshore, data was mixed, and the Brexit saga continued – with no end in sight.

Unsurprisingly, with an election imminent, Budget 2019 focused on short and medium-term income support for households and long-term infrastructure investment while still promising a lasting return to surplus from 2019/20. Please see the essay on the first page detailing the Budget and its implications for monetary policy as well as a video of Our analysis on Westpac IQ.

Turning to the Australian data released this week. On the positive side, Australia’s trade balance reached a record high in February on the back of the elevated iron ore price; and similarly, retail sales and dwelling approvals for February also beat expectations. That being said, the trend for retail sales remains weak, and for dwelling approvals, the upside surprise was solely due to a surge in high-rise apartment approvals that is unlikely to be repeated – note all other approval components were well below expectations. CoreLogic house price data for March meanwhile highlighted that the house price correction is still a fair way from stabilising.

Across the Tasman in New Zealand, Westpac has changed its view on the RBNZ outlook. We are now calling for a cut at the May 2019 meeting and another a year later in May 2020. The justification for this view is the clear concern that the RBNZ has shown over the global backdrop; inflation struggling to return to the 2.0%yr target; and our New Zealand team’s long-held concerns over the economic outlook in the early-2020’s. These rate cuts would take the RBNZ cash rate to 1.25% at May 2020. See the next page for further detail.

Further afield in Asia, the data flow has been constructive, with both the NBS and Caixin manufacturing PMI’s rising above 50 once again – signalling growth for industry. The services sector meanwhile has continued to grow at a solid pace, pointing to still-robust momentum within China’s domestic economy despite external headwinds. We continue to hold a positive view on China, believing that fixed asset investment growth will slowly strengthen and broaden across the economy during 2019. GDP growth will however still be at the lower end of authorities 6.0-6.5% target range for this year, as the softer employment growth of the past year affects consumption.

For China and the broader Asian region, the focus of markets this week has not been the above data but rather signs that a trade agreement between the US and China may (finally) be close. Anecdotes from authorities have been positive, and there have also been press reports of agreement over some terms, including China purchasing more goods from the US over the coming decade – to reduce the US’ trade deficit.

For the US, the headline data print of the week, the employment report, is still to come. Other data has been mixed, with consumer spending and inflation soft, but business sector detail robust. We remain of the view that US GDP growth will end 2019 near trend despite a soft start to the year, in part due to the December/ January Government shutdown.

Finally to Europe and the UK. Updates on the European economy this week confirm a general softness in activity but also underscore sectoral divergence in the economy. While retail sales volumes were shown to be tracking at 2.8%yr and the services and construction PMI’s imply continued steadiness, the manufacturing industry remains in the doldrums. Most notably, German factory orders plunged 4.2% in February and the European manufacturing PMI was revised down to be at lows since 2013.

With the latter front of mind, along with geopolitical uncertainty, the ECB are concerned about the economic outlook, as confirmed in the release of the March meeting minutes. Not much was offered in these minutes in regards to TLTRO-III incentives and the possibility of a tiered deposit rate. It is unlikely that a decision will be made on incentives at next week’s April meeting, but we expect an update in June.

A key uncertainty weighing on Europe regards the UK and Brexit. We are not surprised that little progress was made this week. While PM May and Labour’s Corbyn began negotiations – and reports are that they were “constructive” – a compromise is still yet to be found ahead of the April 12 Brexit date.

At next week’s EU Summit on April 10, the UK will need to present a withdrawal deal to EU-27 leaders or provide guidance on a plan for the way forward. Given the resistance against leaving without a deal, this plan is likely to call for another extension to the Brexit negotiation process. However, this will need to factor in European Parliament elections scheduled for May 23-26.

Chart of the week: Australian Federal Budget

The 2019 Federal Budget has achieved credible surpluses; meaningful tax cuts; and a comprehensive infrastructure plan

The forecast underlying cash balance of $7.1 billion in 2019/20 follows 11 consecutive years of deficit and marks the first surplus since 2007/08.

Overall, new spending in the near term is relatively modest and falls short of a meaningful boost to an economy that slowed to an annualised pace of just 1 per cent in the second half of last year whilst being buffeted by unprecedented house price falls.

The net impact of new spending and tax policy measures is only $9.9bn across the four years to 2021/22 (or $19.7bn if provisions from MYEFO are also included), a relatively modest boost in the context of a $2 trillion economy.

New Zealand: week ahead & data wrap

Starting with a bang

In its April OCR Review, the RBNZ surprised by advising that “more likely direction of the next OCR move is down.” This announcement was followed by broad-based weakness in Tuesday’s Quarterly Survey of Business Confidence. We now expect the RBNZ to cut the OCR in May – the first decision by the newly appointed Monetary Policy Committee. On the back of this change in view we have revised our interest rate and exchange rate forecasts.

We now expect the RBNZ to cut the OCR to 1.5% at its next meeting in May. In its April Statement, the RBNZ was clearly getting nervous about the global economic outlook. The fact that foreign central banks are moving towards more dovish monetary policy stances has been particularly important. If New Zealand fails to follow suit, the RBNZ is worried that the exchange rate could rise, putting downward pressure on inflation which is already struggling to reach the 2% mid-point of the RBNZ’s target band.

The RBNZ is also becoming increasingly doubtful that New Zealand GDP growth will accelerate to the extent it is forecasting in 2019. Recent data on that has been mixed.

Consumer spending and construction data has been strong but this week’s Quarterly Survey of Business Opinion was weak. Not only did headline business confidence fall near September’s 9-year low, but there was also a broad-based deterioration across most key activity and investment indicators. Profits are being squeezed by rising costs and a perceived inability to pass these on to customers, increasing the chances that weak confidence will become self-fulfilling. The survey suggests March quarter GDP growth is likely to be around 0.5%. That’s weaker than the RBNZ’s forecast of 0.8%, and is consistent with an economy that is ticking over rather than picking up.

The labour market leg of the RBNZ’s dual mandate gives less basis for cutting the OCR – unemployment is low and as we saw in this week’s QSBO, firms continued to report that both skilled and unskilled workers remain hard to come by. And while there has been limited upward pressure on wage growth to date, with the unemployment rate expected to linger around its maximum sustainable level for some time yet, we are expecting to see stronger wage growth this year. But with the maximum sustainable level of employment still relatively uncertain, the employment target is unlikely to get in the way if a modest OCR reduction is warranted on inflation grounds.

The May OCR decision will be the first made by the RBNZ’s newly formed Monetary Policy Committee, making this something of a “blank slate” decision. Could a fresh committee conclude that a lower OCR is the way to go? We think yes. Critically, inflation has been below two percent for 7 years (aside from a one quarter petrol induced spike in 2017). And while measures of core inflation are rising, they are still only around 1.5% to 1.7%.

Looking ahead, there remains more risk of inflation undershooting the target than overshooting. The big risk with cutting the OCR is the housing market. An OCR reduction could cause mortgage rates to fall even further, increasing the risk of stoking the housing market which is already booming in many regions beyond Auckland. Which option to go with is a matter of judgement. But with nationwide house price inflation currently at 2.6% and inflation flagging, it is now looking more reasonable to opt for a modestly lower OCR than it looked last year.

Following our forecast cut in May, we expect the RBNZ will leave the door open to a follow-up cut. There is a risk that they follow through on that, but it is more likely that they will keep the OCR at 1.5% for the remainder of 2019.

By the second half of the year the New Zealand economy will be showing clearer signs of improvement due to fiscal stimulus, lower petrol prices and strong construction activity in Auckland. Sentiment about the global growth outlook should also be improving. In addition, the sharp fall in interest rates we’ve seen in recent weeks is set to put downward pressure on mortgage rates which will be a very large stimulus for the housing market.

While we don’t think a second OCR cut in 2019 will be justified, by the early 2020s the introduction of a capital gains tax, the end of the construction boom, and slowing population growth will likely see that change, justifying a lower level of the OCR. We have pencilled in a second cut for May 2020, which would take the OCR down to 1.25%.

This new outlook for interest rates means we now see the outlook for the NZ dollar and longer term interest rates differently. The NZ dollar fell sharply following the RBNZ’s dovish shift. The NZD/USD is currently around 67.50. We expect it to fall further in the coming months and are forecasting 65c by the end of June. However, with markets pricing in a high likelihood of two rate cuts by the end of the year, there’s scope for disappointment (and a slightly stronger NZD/USD) if the RBNZ fails to deliver a second rate cut – as we expect. We forecast the NZD/USD to temporarily rebound in late 2019 before heading south again by the middle of next year as the RBNZ cuts once more.

Data Previews

Aus Feb housing finance (no.)

  • Apr 9, Last: –1.2%, WBC f/c: 1.0%
  • Mkt f/c: 0.5%, Range: -3.1% to 1.8%

Housing finance approvals posted a further decline in Jan, albeit a slightly milder one than in previous months for owner occupiers, the number of approvals ex refi down 1.2% vs average declines of 1.6% over the second half of 2018. The value of investor loans ex refi posted a larger 4.1% fall.

Industry data covering the major banks suggests Feb was a touch firmer. We expect the number of owner occupier loans to edge 1% higher. However, the value of investor loans is expected to see further softening.

Aus Apr Westpac-MI Consumer Sentiment

  • Apr 10 Last: 98.8

The Westpac Melbourne Institute Index fell 4.8% in March, the consumer mood clearly jolted by the disappointing December quarter national accounts released in the survey week. At 98.8, the March read is the lowest since September 2017, although this ‘cautiously pessimistic’ level is still above the average recorded in 2017.

The April survey is in the field from April 1-6 and will capture reactions to the Federal Budget, which included additional tax relief measures for households. Concerns around the economic outlook are likely to linger. Other factors that may impact include: a continued lift in the ASX, now up nearly 10% from its late 2018 levels; but negatives around petrol prices (average pump prices nationally up 18c/l since early Feb) and continued declines in house prices.

NZ Feb REINZ house sales and prices

  • Apr 8 – 13 (tbc), Sales last: -5.8%, Prices last: 3.2%yr

Over the past year house prices have been falling slowly in Auckland and Canterbury, and rising very rapidly in most other places. The pace of nationwide price inflation has picked up a little in recent months.

We expect a mixed report this month. Over the past two months, sales have dropped sharply and available stock has increased in Auckland. This suggests Auckland prices will soon weaken further. But elsewhere, prices are expected to keep rising rapidly.

Mortgage rates are plunging, which will stimulate the market later this year. But the Government may announce a capital gains tax, which will have the opposite effect.

NZ Feb retail card spending

  • April 12, Last: +0.9%, WBC : +0.4

Retail spending rose by 0.9% in February. That marked a return to trend for retail spending after some sharp swings in previous months. February’s gain was supported by the reversal of earlier sharp oil price increases that dampened spending last year. Retail spending has also been boosted by the increases in government spending now rippling through the economy (including transfers to households as part of the Governments’ Families Package).

We’re expecting a moderate 0.4% rise in retail spending in March, with only a small 0.1% gain in core (ex-fuel) categories. Recent increases in petrol prices will dampen spending in other areas. There has also been softness in the housing market that will dampen spending appetites. On top of those factors, March saw a softening in consumer confidence.

Europe Apr ECB meeting

April’s meeting follows a significant dovish shift in March. While before, the ECB held steady in their confidence that the growth slowdown would be temporary, in March they have factored in weakness persisting through H1 2019.

All up, this saw large downward revisions in the economic projections, the extension of interest rate policy forward guidance to rates expected to be on hold at least through the end of 2019, and the announcement of a new Targeted Long-Term Refinancing Operations (TLTRO) package in response to the upcoming maturities.

Full detail of TLTRO-III is to be announced. At first glance TLTRO-III appears less favourable than its predecessor, but the ECB have indicated that there will be incentives (as did TLTRO-II). We expect an announcement in June with April’s discussion providing valuable clues. Of secondary importance will be discussion on side effects of negative interest rates and the potential for a tiered deposit rate.

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