Economic and Financial Market Update: The RBA & Looking For Rainbows
Summary:
- The RBA kept the cash rate at 0.75% following the February meeting;
- The tone of the upcoming statement was a little more upbeat;
- The RBA made it clear they will cut rates again if needed.
‘It never rains but what it pours
If lady luck should happen to desert you’
- Judy Garland
The great Judy Garland hasn’t been the only person who has ever said it never rains but it pours. The latest surely are those that follow the economy. The Tweens decade was one characterised by disappointing income growth. Every time the economy started to power up something happened to slow things down again. In recent years that has included an overly aggressive Federal Reserve, a US-China Trade War and (most recently) the Chinese coronavirus. Domestically there has been the bushfires. The big picture has been the unwinding of the mining boom.
The RBA provided an update of its economic view following the February meeting (more details will be included in Governor Lowe’s speech and the quarterly Statement of Monetary Policy). As expected the RBA kept rates unchanged. The RBA is forecasting better times ahead. But it also made it clear it will cut rates again if those times do not arrive.
Below is a comparison of their latest views with the last time the RBA updated its economic thoughts (November).
Global Economy
November
While the outlook for the global economy remains reasonable, the risks are tilted to the downside. The US–China trade and technology disputes continue to affect international trade flows and investment as businesses scale back spending plans because of the uncertainty. At the same time, in most advanced economies, unemployment rates are low and wages growth has picked up, although inflation remains low. In China, the authorities have taken steps to support the economy while continuing to address risks in the financial system.
February
The outlook for the global economy remains reasonable. There have been signs that the slowdown in global growth that started in 2018 is coming to an end. Global growth is expected to be a little stronger this year and next than it was last year and inflation remains low almost everywhere. One continuing source of uncertainty, despite recent progress, is the trade and technology dispute between the US and China, which has affected international trade flows and investment. Another source of uncertainty is the coronavirus, which is having a significant effect on the Chinese economy at present. It is too early to determine how long-lasting the impact will be.
Comment:
The economic numbers are looking a little better, notably in Europe. Manufacturing had a tough 2019. But there have been promising signs in the most recent numbers. Unemployment rates in many countries remain low. Service and construction sectors are typically in decent shape. The RBA world economy view looks to be a little more upbeat.
China remains the big concern. In recent years the Chinese Government has had a tough battle trying to keep growth strong while changing its economic model in order to reduce debt, pollution and income inequality. That battle got harder when they also had to start fighting a trade war. But it has got even tougher with the Flu outbreak.
Everyone agrees that the dramatic global steps taken to combat the flu virus will have a substantial economic impact in Q1, both in China and the World. The RBA said that it is too early to understand the implications. How big the economic impact ends up will depend upon:
- How long the spreading of the virus takes place before with an antidote is found or the rate of increase of new cases declines;
- Does the virus have any long-lasting impact upon household and business confidence;
- Does the virus result in changes in the way China interacts with the global economy (eg, less Chinese students studying abroad).
The experience of the past couple of decades is that the negative impact of the virus will be short term. The Chinese Government will do its best to limit any economic fallout. It has already reduced interest rates and will almost certainly increase spending substantially. Other Governments (particularly in Asia) will also provide their economies with a decent fiscal boost. But right now it is the uncertainty that is driving the economic commentary.
Financial Markets
November
Interest rates are very low around the world and a number of central banks have eased monetary policy in response to the persistent downside risks and subdued inflation. Expectations of further monetary easing have generally been scaled back over the past month and financial market sentiment has improved a little. Even so, long-term government bond yields are around record lows in many countries, including Australia. Borrowing rates for both businesses and households are also at historically low levels. The Australian dollar is at the lower end of its range over recent times.
February
Interest rates are very low around the world and a number of central banks eased monetary policy over the second half of last year. There is an expectation of a little further monetary easing in some economies. Long-term government bond yields are around record lows in many countries, including Australia. Borrowing rates for both businesses and households are at historically low levels. The Australian dollar is around its lowest level over recent times.
Comment:
Up to the appearance of the coronavirus markets had moved to pricing developed country central banks keeping rates low (and unchanged) for 2020 and a better economy. Emerging market economies were expected to have a good year, with the possibility of further rate reductions.
There has been concern that many asset markets were overvalued by some traditional valuation metrics (such as price earnings ratios for equities, rental yields for property). The biggest driver of asset markets has been recognition that interest rates will stay low for an extended period.
At the time of writing the $A is trading well under its average value against the $US since deregulation (around 75c). Mostly that is a reflection of the strength of the $US (because of the robust US economy). Against all trading partners, the $A is closer to its long-term average.
Australian Economy
November
The outlook for the Australian economy is little changed from three months ago. After a soft patch in the second half of last year, a gentle turning point appears to have been reached. The central scenario is for the Australian economy to grow by around 2¼ per cent this year and then for growth gradually to pick up to around 3 per cent in 2021. The low level of interest rates, recent tax cuts, ongoing spending on infrastructure, the upswing in housing prices in some markets and a brighter outlook for the resources sector should all support growth. The main domestic uncertainty continues to be the outlook for consumption, with the sustained period of only modest increases in household disposable income continuing to weigh on consumer spending. Other sources of uncertainty include the effects of the drought and the evolution of the housing construction cycle.
February
The central scenario is for the Australian economy to grow by around 2¾ per cent this year and 3 per cent next year, which would be a step up from the growth rates over the past two years. In the short term, the bushfires and the coronavirus outbreak will temporarily weigh on domestic growth. The household sector has been adjusting to a protracted period of slow wages growth and, last year, to a decline in housing prices, with the result that consumption has been quite weak. Following this period of balance-sheet adjustment, consumption growth is expected to pick up gradually. The overall outlook is also being supported by the low level of interest rates, recent tax refunds, ongoing spending on infrastructure, a brighter outlook for the resources sector and, later this year, an expected recovery in residential construction.
Comment:
There had been some better signs for the Australian economy in Q4. Rising house prices helped the real estate sector, also likely giving consumers’ one reason to spend. There are signs that the residential construction cycle was bottoming. Miners were boosting Capex spending. Infrastructure and NDIS spending remained strong. Orders books were starting to be filled.
And then came the bushfires and coronavirus. The Treasurer thinks it is possible that it could result in a negative quarter of GDP growth. Subsequent quarters will most likely be stronger as delayed spending and rebuilding takes place. The economy will almost certainly receive a decent fiscal boost this year with the Government no longer committed to a Budget surplus.
The RBA appears to be a bit more confident the domestic economic outlook. The consumer remains the major concern.
Labour Market
November
Employment has continued to grow strongly and has been matched by strong growth in labour supply, with labour force participation at a record high. The unemployment rate has remained steady at around 5¼ per cent over recent months. It is expected to remain around this level for some time, before gradually declining to a little below 5 per cent in 2021. Wages growth remains subdued and is expected to remain at around its current rate for some time yet. A further gradual lift in wages growth would be a welcome development and is needed for inflation to be sustainably within the 2–3 per cent target range. Taken together, recent outcomes suggest that the Australian economy can sustain lower rates of unemployment and underemployment.
February
The unemployment rate declined in December to 5.1 per cent. It is expected to remain around this level for some time, before gradually declining to a little below 5 per cent in 2021. Wages growth is subdued and is expected to remain at around its current rate for some time yet. A further gradual lift in wages growth would be a welcome development and is needed for inflation to be sustainably within the 2–3 per cent target range. Taken together, recent outcomes suggest that the Australian economy can sustain lower rates of unemployment and underemployment.
Comment:
The most pleasant domestic economic surprise of 2019 was the strength of the jobs market. The economy created over 20,000 jobs per month last year. This enabled the unemployment rate to decline a little and the participation rate to remain near record highs.
The forward indicators are mixed. Job ads have been a bit weaker and consumer concerns about unemployment have been rising. But firm employment intentions have improved and job vacancy data is still at a high level. But we are still some way from the 4-4.5% unemployment rate that will be necessary to get wages growth sustainably higher.
Inflation
November
The recent inflation data were broadly as expected, with headline inflation at 1.7 per cent over the year to the September quarter. The central scenario remains for inflation to pick up, but to do so only gradually. In both headline and underlying terms, inflation is expected to be close to 2 per cent in 2020 and 2021.
February
Inflation remains low and stable. Over 2019, CPI inflation was 1.8 per cent and underlying inflation was a little lower than this. The central scenario is for CPI inflation to be around 2 per cent in the near term and to fluctuate around that rate over the next couple of years. In underlying terms, inflation is expected to increase gradually to 2 per cent over the next couple of years.
Comment:
The most recent CPI figures indicated that inflation is not falling but it is not yet clear that it is rising. Food prices have had a decent increase because of drought and African swine flu (impacting meat prices). Petrol prices have also risen. Falling rents have held down inflation. Economic growth has not been strong enough for long enough to get inflation rate heading sustainably higher.
A big issue has been expectations of future inflation. Providing expectations remain consistent with the RBA’s 2-3% target temporary low (or high) inflation outcomes do not matter. But there have been signs that sustained low inflation outcomes over the past couple of years has led to a decline of expectations. And as the experience of Japan highlights, once expectations stay low it becomes difficult to achieve higher inflation.
The RBA expects a modest rise of inflation over the next couple of years. The 2% forecast may end up being tough to achieve given the US economy has struggled to sustain such an inflation rate with a substantially lower unemployment rate.
Financial System
November
There are further signs of a turnaround in established housing markets, especially in Sydney and Melbourne. In contrast, new dwelling activity is still declining and growth in housing credit remains low. Demand for credit by investors is subdued and credit conditions, especially for small and medium-sized businesses, remain tight. Mortgage rates are at record lows and there is strong competition for borrowers of high credit quality.
February
There are continuing signs of a pick-up in established housing markets. This is especially so in Sydney and Melbourne, but prices in some other markets have also increased. Mortgage loan commitments have also picked up, although demand for credit by investors remains subdued. Mortgage rates are at record lows and there is strong competition for borrowers of high credit quality. Credit conditions for small and medium-sized businesses remain tight.
Comment:
Despite the very low interest rates, credit growth has been weak. Housing finance approvals are rising, and credit for owner-occupiers looks to be on the up. Housing prices rose notably in Sydney and Melbourne in the second half of last year, and prices now appear to be increasing in all cities (including Perth). The weak economy is keeping a lid on business demand for credit. Firms report that borrowing conditions have eased a little although they remain tight by the standards of recent years.
Interest Rate Decision
November
The easing of monetary policy since June is supporting employment and income growth in Australia and a return of inflation to the medium-term target range. Given global developments and the evidence of the spare capacity in the Australian economy, it is reasonable to expect that an extended period of low interest rates will be required in Australia to reach full employment and achieve the inflation target. The Board will continue to monitor developments, including in the labour market, and is prepared to ease monetary policy further if needed to support sustainable growth in the economy, full employment and the achievement of the inflation target over time.
February
The easing of monetary policy last year is supporting employment and income growth in Australia and a return of inflation to the medium-term target range. The lower cash rate has put downward pressure on the exchange rate, which is supporting activity across a range of industries. Lower interest rates have assisted with the process of household balance sheet adjustment. They have also boosted asset prices, which in time should lead to increased spending, including on residential construction. Progress is expected towards the inflation target and towards full employment, but that progress is expected to remain gradual.
With interest rates having already been reduced to a very low level and recognising the long and variable lags in the transmission of monetary policy, the Board decided to hold the cash rate steady at this meeting. Due to both global and domestic factors, it is reasonable to expect that an extended period of low interest rates will be required in Australia to reach full employment and achieve the inflation target. The Board will continue to monitor developments carefully, including in the labour market. It remains prepared to ease monetary policy further if needed to support sustainable growth in the economy, full employment and the achievement of the inflation target over time.
Comment:
Following the announcement of the February rate decision, financial markets still priced one quarter point rate cut by Q2 2020, but had reduced the chances of a second move. Economists agree, although the median economist view has another reduction of rates by early next year.
The RBA has made it pretty clear that there is very little chance of a rate hike any time over the next 1-2 years. The RBA will be happy if they are able to keep rates unchanged over that period. But they have also made it clear that if necessary they will reduce rates further. Two indicators to watch are whether inflation expectations decline further and whether the unemployment rate rises.
Date |
Financial Markets (as at 4 Feb 2020) |
Economist Views (Reuters survey conducted 31 Jan 2020) |
||
Median |
Low |
High |
||
Mar 2020 |
0.68 |
0.75 |
0.25 |
0.75 |
June 2020 |
0.42 |
0.5 |
0.25 |
0.75 |
Sept 2020 |
0.42 |
0.5 |
0.25 |
0.75 |
Dec 2020 |
0.37 |
0.5 |
0.25 |
0.75 |
Mar 2021 |
0.39 |
0.25 |
0.25 |
1.00 |
June 2021 |
0.40 |
0.25 |
0.25 |
1.00 |
Sources: Reuters, Refinitiv
Judy Garland went on to say ‘Smile when you should cry. For every cloud there’ll be a rainbow.’ Right now smiles and rainbows are hard to find. One day they will return. Hopefully that day is soon.
We live in interesting times!
Regards,
Peter Munckton - Chief Economist
