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Reserve Bank signals rate cut for June

Reserve Bank Governor speech; RBA Board minutes; Consumer confidence

Interest rate outlook: In a speech titled “The Economic Outlook and Monetary Policy” today in Brisbane, Reserve Bank Governor Philip Lowe said that “a lower cash rate would support employment growth and bring forward the time when inflation is consistent with the target. Given this assessment, at our meeting in two weeks’ time, we will consider the case for lower interest rates.” CommSec expects interest rates to be cut in June and August.

Reserve Bank Board Minutes: The Reserve Bank has acknowledged that an interest rate cut may be needed should conditions in the labour market deteriorate, noting “members considered the scenario where there was no further improvement in the labour market in the period ahead, recognising that in those circumstances a decrease in the cash rate would likely be appropriate.”

Consumer confidence: The weekly ANZ-Roy Morgan consumer confidence rating rose by 2.1 per cent to 117.2 points. Consumer sentiment is above both the short-term average of 114.4 points held since 2014 and the longer term average of 113.1 points since 1990.

The consumer confidence figures have implications for retailers, and other consumer-focussed businesses. The Reserve Bank Board minutes provides guidance on interest rate settings.

What does it all mean?

• Reserve Bank policymakers have laid the groundwork for an interest rate cut in June. In fact, Reserve Bank Governor Philip Lowe has included an explicit easing bias in his speech in Brisbane today, confirming that “at our meeting in two weeks’ time, we will consider the case for lower interest rates.” CommSec now expects interest rates to be cut in June and August.

• Given recent Reserve Bank emphasis on labour market developments, it appears that Dr. Lowe has ‘thrown in the towel’ after the mixed April jobs report: “recently, though, some labour market indicators have softened a little: the unemployment rate ticked up to 5.2 per cent in April; the underemployment rate has also moved a little higher as there are more part-time workers who are seeking additional hours; job advertisements have declined; and hiring intentions have come off their earlier highs.”

• But Reserve Bank Board members are reluctant rate cutters, emphasising in the May 7 Board minutes that “the effect on the economy of lower interest rates could be expected to be smaller than in the past.”

• Policymakers, however, have seemingly acknowledged through gritted teeth that a rate cut could act as a mild stimulus to the broader economy as “a lower level of interest rates could still be expected to support the economy through a depreciation of the exchange rate and by reducing required interest payments on borrowing, freeing up cash for other expenditure.” And its forecast scenario implies that “without an easing in monetary policy over the next six months, growth and inflation outcomes would be expected to be less favourable than the central scenario.”

• The Governor has also implored the re-elected Morrison government to continue to stimulate the economy through fiscal spending initiatives, such as tax cuts and public transport-related infrastructure spending.

• The Federal election has been and gone. Some people surveyed by Roy Morgan and ANZ would’ve known the election result on Sunday, but next week’s survey will provide a clearer picture of what consumers really think of the re-election of the Morrison government and Reserve Bank Governor Philip Lowe’s speech today.

• News that the government may be forced to delay the implementation of personal income tax cuts effective on July 1 because of a procedural hold up over the return of Parliament will frustrate electors. That said, tax offsets worth up to $530 a year were legislated in 2018. And the increasing likelihood of an official cash rate and potential reduction in variable mortgage rates (fixed mortgage rates have already been cut) could boost sentiment.

What do the figures show?

Consumer Sentiment

• The weekly ANZ-Roy Morgan consumer confidence rating rose by 2.1 per cent to 117.2 points. Consumer sentiment is above both the short-term average of 114.4 points held since 2014 and the longer term average of 113.1 points since 1990.

• All five major components of the index rose last week:

The estimate of family finances compared with a year ago was up from +8.6 points to +9.1 points;

The estimate of family finances over the next year was up from +27.6 points to +29.1 points;

Economic conditions over the next 12 months was up from +3.4 points to +7.3 points;

Economic conditions over the next 5 years was up from +10.7 points to +11.7 points;

The measure of whether it was a good time to buy a major household item was up from +23.9 points to +29.0 points.

• The measure of inflation expectations fell from 4.5 per cent to 4.0 per cent.

Reserve Bank Board meeting minutes

• Interest rate stability: “Taking into account all the available information, including the various uncertainties about the outlook, members judged that it was appropriate to hold the stance of monetary policy unchanged at this meeting, noting that holding monetary policy steady had enabled the Bank to be a source of stability and confidence over recent years.”

• Rate cut scenario: “…members discussed the scenario where inflation did not move any higher and unemployment trended up, recognising that in those circumstances a decrease in the cash rate would likely be appropriate.” And “members noted that the central forecast scenario was based on the usual technical assumption that the cash rate followed the path implied by market pricing, which suggested interest rates were expected to be lower over the next six months. This implied that, without an easing in monetary policy over the next six months, growth and inflation outcomes would be expected to be less favourable than the central scenario.”

• Job market outlook: “Leading indicators of labour demand had eased over recent months and provided a mixed picture of the near-term outlook.”

• Wages outlook: “Members noted that the forecasts for the labour market suggested that there would be some spare capacity in the labour market throughout the forecast period, although there was uncertainty about how quickly the spare capacity would decline and how progress would feed into wage pressures.”

• Inflation outlook: “Members noted that the recent CPI data had led the Bank to reassess the disinflationary effects of the weak housing market. Combined with the lower GDP growth outlook, this had led to a downward revision to the inflation outlook, although there was also some uncertainty about the persistence of downward pressure from utilities and administered price changes and the effect of housing market weakness.”

• On its forecasts, including consumer spending: “…members also recognised that there were risks to the forecasts in both directions. The risks to the global economy remained tilted to the downside, with uncertainty remaining around the evolution of international trade policy. Domestically, the outlook for household consumption remained a key uncertainty, with the risks tilted to the downside given ongoing low income growth and the adjustment occurring in housing markets. On the upside, it was possible that the combined effects of continued accommodative financial conditions, the increase in Australia’s terms of trade, a renewed expansion in the resources sector and the expected lift in household disposable income growth would result in stronger growth in output than in the central forecast scenario.”

What is the importance of the economic data?

• The ANZ/Roy Morgan weekly survey of consumer confidence closely tracks the monthly Westpac/Melbourne Institute consumer sentiment index but the former measure is a timelier assessment of consumer attitudes and is now closely tracked by the Reserve Bank.

• The Reserve Bank releases minutes of its monthly Board meeting a fortnight after the event. The minutes give a guide to Reserve Bank thinking on interest rate settings.
What are the implications for interest rates and investors?

• The Reserve Bank, in our view, is likely to cut interest rates at both the June and August Board meetings, acknowledging some recent weakness in the labour market. However, Dr. Lowe has acknowledged that “the labour market has surprised on the upside over recent times, and it could do so again. While we can’t rule out this possibility, the recent flow of data makes it seem less likely.”

• The Reserve Bank Governor had previously thought that if unemployment fell below 5 per cent, then inflation was likely to rise. The Governor now believes that the jobless rate can fall further without leading to a spike in inflation.

• And in his Question & Answer session Dr. Lowe said “Australia can and should have a lower unemployment rate.” Worries about consumer spending were highlighted with “delay in tax cuts will slow household income growth by 0.3 per cent.” And while the “inflation target remains central to the policy framework”, Governor Lowe said that it “will take some time to get inflation above 2 per cent.” On APRA’s decision today to ease home lending rules, Dr. Lowe said that the “move [was] complimentary to monetary policy, not a substitute.”

• The May 7 Board minutes were decidedly less upbeat and optimistic than the previous month, laying the groundwork for Dr. Lowe’s easing bias later in the day. The previous assessment in April that “members agreed that there was not a strong case for a near-term adjustment in monetary policy” was removed. And “members also discussed the scenario where inflation did not move any higher and unemployment trended up, noting that a decrease in the cash rate would likely be appropriate in these circumstances.”

• With inflation contained, consumer spending restrained, the global economic backdrop less favourable due to trade tensions and weaker leading indicators of jobs growth, further monetary policy support for the economy is required. Proposed tax cuts, infrastructure spending and policies to support the housing market are providing additional stimulus.

• Consumer confidence is OK without being super-positive. Investors reacted favourably yesterday to the Morrison government’s re-election with the Australian sharemarket rising by the most in three months to close at its highest level since December 2007. But perhaps more important is the reaction of the business community. Business confidence is near five-year lows and job hiring intentions appear to have peaked. Business investment, job creation and pay rises remain critical to the consumer and interest rate outlook. The next NAB survey will be very interesting.

• CommSec expects interest rates to be cut in June and August.

published by Ryan Felsman, Senior Economist, CommSec