Australia | Jun 05 2019
How many more RBA rate cuts ahead? Opinions vary, but it will all depend on a fall in unemployment and subsequent rise in inflation.
-Unemployment the critical factor for RBA
-Regulatory and fiscal measures play their part
-Will further cuts even help?
By Greg Peel
It’s not about a falling housing market, it’s all about jobs, and subsequently inflation.
After a surprisingly weak CPI result for the March quarter the RBA flagged a rate cut ahead. The only point of debate was whether it would be as soon as May, but given the election in May, June seemed more likely, and so it has come to pass.
A falling housing market and the possibility of increased mortgage defaults seemed like justification to cut the cash rate to stem the tide, but yesterday the RBA statement noted, in relation to housing, “Conditions remained soft, although in some markets the rate of price decline has slowed and auction clearance rates have increased”.
This graph tells the tale:
The housing market is far from irrelevant, nevertheless. The graph is signalling a bottom in house price declines is possibly not far off, and that’s before APRA formerly lowers its mortgage serviceability rate requirement and yesterday’s announced mortgage rate cuts from the banks have their impact.
The main issue with falling housing prices is not as much of mortgage default risk as it is of the “wealth effect”. Even though a mortgaged homeowner may have no desire or need to sell into a falling market, the usual response is to hold off on discretionary spending. In rising housing markets people feel “rich” and go out spending. In falling housing markets the opposite is true.
And that keeps a lid on consumer price inflation. But the signs are improving for the housing market, yet the RBA saw reason to cut. While the board gave a nod to the risks inherent in an all-out global trade war, the primary concern is weak wage growth, which is the result of so-called “spare capacity” in the labour market.
While a 5% unemployment rate was once considered “full employment”, in today’s world that “neutral” rate is lower. The RBA wants to see the unemployment rate fall. And it wants to see the underemployment rate fall. A lot of the “spare capacity” is down to those with part-time jobs wanting either full-time jobs or at least more hours.
A reduction of that spare capacity is required to lift wage growth. Growing wages allow workers to spend, and spending supports higher inflation. The RBA cut its cash rate to an historical low 1.25% yesterday with the specific intention of reducing unemployment. This is the remaining weak factor in an economic outlook that hasn’t otherwise much changed.
Will it work? Clearly few economists believe so. For starters, rate cuts take many months to flow through the system and have their impact. The RBA remains hopeful, but recent labour market indicators suggest otherwise. Consensus has it that a second cut as early as next month would be forthcoming but for a lack of data in the lead-up, and the RBA has suggested in not so many words it is now data-dependent.
As I write, Australia’s March quarter GDP result has just come in at 0.4% growth, slightly below consensus expectation, but 1.8% annual growth, in line with expectation. That’s the slowest annual rate since the GFC.
Within the number, government spending contributed the most to growth, and strong iron ore prices did their part. But the key for inflation expectations is household consumption, which slowed to a growth rate of a mere 0.1%.
The result, while reflecting conditions as far back as January, supports further rate cut. Economists nonetheless agree a more critical data release will be the June quarter CPI result, which will not be delivered until after the July RBA meeting. While headline inflation will likely rise on higher oil prices in the period, core inflation is not expected to improve from the weak march quarter result.
Hence consensus has it that August is as much as a lay-down misere for a second rate cut as June was for the first.
Indeed, the bulk of economist responses to the rate cut were published after the statement release but before RBA Governor Philip Lowe spoke last night. Before the speech economists were in disagreement about whether the nuances of the statement suggested a more dovish tone. But last night he said:
“That the Board has not yet made a decision, but it is not unreasonable to expect a lower cash rate. Our latest set of forecasts were prepared on the assumption that the cash rate would follow the path implied by market pricing, which was for the cash rate to be around 1 per cent by the end of the year.”
So bake in August. The question then is: How many more? Here, opinions differ.
Other factors
The RBA has made it clear that monetary policy alone cannot be expected to stimulate economic growth, and the lower rates go the less the incremental benefit of cuts. What is required are “unconventional tools” and fiscal policy support.
As to “unconventional tools”, APRA has already come to the party. A reduction in the mortgage serviceability rate is not going to send house prices and mortgage demand flying back up again, but it does help to improve confidence.
Last week the Fair Work Commission granted a 3% increase to the minimum wage. Given this is close to twice the current rate of inflation, it is somewhat “unconventional”, and will add to the spending power of lower-income workers.
On the fiscal side, it’s a matter of what won’t happen as much as what will happen now the Coalition has been returned to power.
Negative gearing will not be restricted, which is supportive of a return to confidence in housing and increased investor demand. Cash refunds for dividend franking will not be scrapped, meaning many Australians can now rely on (and thus spend) significant income streams.
The Coalition is set to deliver across-the-board tax cuts. CBA economists have noted that substantial income tax rebates will flow to around 10m low-to-middle income earners from as early as mid-July. In total around $7.5bn in rebates will be received in FY20 which, CBA calculates, is equivalent to 0.6% of disposable income or 50 basis points in interest rate cuts.
Lastly on the fiscal front, albeit totally out of the government’s control, is the impact of the surging iron ore price. Spot iron ore is currently bouncing around the US$100/t mark and may well go higher in the short term. When the Coalition delivered its budget ahead of the election, and promised a swift return to surplus, its iron ore price assumption was US$55/t.
Currently, the market is pricing in a risk that the RBA cash rate will fall below 1% in 2020, and beyond that there is a risk “unconventional” monetary policy will be required, which basically suggests quantitative easing. “Our view,” says CBA, “is that such an outcome would require an economic scenario that is considerably more bearish than our own forecasts”.
CBA sits at the more “hawkish” end of expectations.
Range of expectations
JP Morgan believes the RBA statement was more dovish than the market appreciates at present, and “at present” was before Philip Lowe spoke last night. Specifically the final sentence:
“The Board will continue to monitor developments in the labour market closely and adjust monetary policy to support sustainable growth in the economy and the achievement of the inflation target over time.”
How much “adjustment”? JPMorgan sits at the opposite end of consensus from CBA, expecting a rate cut in August and two more in the first half of 2020.
Morgan Stanley is another expecting an August rate cut, but then expects the RBA to remain on hold. The reason being it takes some time for the impact of cuts to flow through the economy and the board will need to see how things play out. It will also want to see what impact the APRA cut and income tax cuts bring about.
However, as exciting as all these stimulatory measures may be, Morgan Stanley expects rate cuts to provide only limited stimulus to the economy, and “little” in the near-term. MS economists don’t see much of a pass-through to spending and are sceptical that a significant pick-up in credit growth will follow.
“Animal spirits will need to be rekindled to see a more effective and sustained monetary stimulus”.
UBS believes the RBA’s GDP forecasts remain “optimistic” and will be downgraded by August. UBS has booked in an August cut but sees risk of more easing below 1%.
Potential triggers to this would be weak consumption within the March quarter GDP result (which we now know is the case), unemployment failing to improve, June quarter underlying CPI inflation failing to lift from the March quarter historic low, and the risk of the global trade war escalating.
The latter risk was also flagged as an issue in the RBA statement.
Economists across the board land somewhere between one and three more rate cuts ahead. BIS Oxford Economics suggests two more to 0.75%. Franklin Templeton is backing three to 0.5%. Janus Henderson so far sees just the one cut in August. ANZ Bank has moved a prior forecast of another rate cut in November forward to August but believes a move below 1% is “not imminent”.
While it is the US Federal Reserve that made the expression “data-dependent” a buzzword, the same now is explicitly true for the RBA. The RBA will need to assess the data, and see how other measures (APRA, government fiscal policy) play out. As to how long the RBA will allow for such an assessment is unclear, and as to whether the board believes a cut below 1% is going to help at all is also not certain.
It does appear certain nonetheless, as far as economists are concerned, that another cut is coming in August.
Technical limitations
If you are reading this story through a third party distribution channel and you cannot see charts included, we apologise, but technical limitations are to blame.
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