Market pricing implies 10% chance interest rates will go lower: Gareth Aird
GUEST OBSERVATION
The December RBA minutes are consistent with the recent narrative out of the RBA which points to policy on hold, according to Commonwealth Bank's economic update.
The level of inflation and spare capacity in the economy gives the bank scope to cut rates if the economic data makes the case.
But today’s minutes suggest it would take a shift in the economic landscape for the cash rate to move lower from here.
To recap, the RBA left the cash rate unchanged at 1.5% at the December board meeting. And the final paragraph contained an unchanged neutral bias.
This was reaffirmed in today’s minutes.
Namely, that: “having eased monetary policy earlier in the year, the Board judged that holding the stance of policy unchanged would be consistent with sustainable growth in the economy and achieving the inflation target over time.”
"In our view, there is a paragraph in the December minutes that contains the thumb print of new governor Philip Lowe," the updated stated.
The key lines being that the board discussed the “effect of lower interest rates on asset prices and the decisions by households to borrow, particularly given the already high levels of household debt”.
“The Board had sought to balance the benefits of lower interest rates in supporting growth and achieving the inflation target with the potential risks to household balance sheets.”
"Members recognised that this balance would need to be kept under review.”
These are indications that the RBA, under Governor Lowe, is placing a little more emphasis in policy settings on asset prices and financial stability than it did under former governor Stevens.
Here we recall that there have been a series of developments since RBA governor Lowe took the helm that mean the hurdle for more policy easing is a notch higher than it was under Glenn Stevens.
First, there were tweaks to the RBA’s policy framework. The inflation target was reaffirmed as 2-3% per annum.
But “on average over the cycle” was replaced with “over time”. There was also a drafting change that, at least cosmetically, makes the link between monetary policy and financial stability a little more direct.
These two changes point to a central bank that appears more willing to tolerate inflation outside of the target band for a little longer than they may have done in the past.
On the international economy, the bank is a little more upbeat than previously, noting that developments had been “more positive” in recent months and that the Chinese economy had “remained resilient”.
The RBA is a little more hawkish on global inflation, noting that the outlook is more “balanced” than it has been for a while.
On the domestic economy, the RBA noted that, “year-ended growth was expected to decline”. Here we note that the December board meeting predates the QIII GDP ‘shocker’.
And while the RBA was expecting a soft print, the 0.5% fall in GDP would not have been in their growth profile.
As such, we expect the bank to downgrade their GDP forecasts in the February statement on monetary policy (SMP).
Growth is expected to pick up to be “above potential” later in the forecast period as the impact of declining mining investment on the economy wanes.
"We agree and would add that on our estimates we are about 85% through the expected decline in mining investment," the update stated.
The RBA lacked conviction in its assessment on the labour market by indicating that there was still “considerable uncertainty” about its “momentum”.
Clearly the bank is struggling with the rare combination of a downward trend in both employment growth and the unemployment rate.
On that score, last week’s comprehensively strong November employment report will settle some nerves in Martin Place around the health of the labour market.
The pulse of jobs growth was easing into the November print (which predates the December board meeting) so the solid increase in jobs over the month (all full-time), coupled with a lift in participation and fall in the underutilisation rate would have been a welcome update.
Interestingly, the RBA mentioned a new hours-based measure of labour market underutilisation that had declined to a similar extent as the unemployment rate.
The Bbank stuck to the recent script on the housing market by noting that: “Conditions had strengthened overall over preceding months, although there was considerable variation across the country.”
On the AUD, the Board had very little to say which is probably related to their satisfaction with what has been happening.
Commodity prices have been firming, but since mid-November (i.e. over the past month) the AUD has fallen 41⁄4% against the USD and 13⁄4% on a TWI basis.
The fall largely reflects USD strength which is the ideal outcome for the Australian economy at the moment.
The Outlook
With no meeting in January, the next RBA Board meeting is seven-odd weeks away.
There will be a lot of economic data out between now and then. And overlying that, financial markets will continue to adjust to the new economic paradigm under a Trump presidency.
We think that the RBA faces a tough job in returning inflation to target. But new Governor Philip Lowe looks more willing to tolerate inflation outside of the target band if it reduces the risk of financial imbalances and the further build of up debt in the household sector.
In addition to today’s minutes, governor Lowe’s comments from his CEDA address in November that: “It is unlikely to be in the public interest, given current projections for the economy, to encourage a noticeable rise in household indebtedness, even if doing so might encourage slightly faster consumption growth in the short term” are still ringing in our ears."
"To us, Lowe’s comments are a strong hint that the governor doesn’t want to take the cash rate lower. And he reminded us today that the cash rate had been “lowered in aggregate by 31⁄4 ppts” over this easing cycle," the update stated.
The risks over the next year continue to lie with a cut and the market is pricing in a small (10%) chance that policy is eased again.
But the house view is that those risks don’t materialise and we have policy on hold at 1.5% over 2017.
Gareth Aird is senior economist with Commonwealth Bank.
