The statement announcing the decision highlighted the Committee's confidence in the outlook, assessing there to be the need for "some further gradual increases in the target range for the federal funds rate" providing that the economy progresses in line with their expectations. Those expectations point to growth in the US economy moderating in 2018 (from 3.1% to 3%) and in 2019 (from 2.5% to 2.3%) but still expanding at an above-potential pace out to 2020, supporting labour market conditions and inflation around the 2% target. The moderation in the growth forecasts references uncertainty referred to by Chair Jerome Powell as "cross-currents" from slowing momentum in the global economy and financial market volatility.
In response, and as our chart of the week shows, the Committee's median projections in the revised 'dot plot' now show an implied expectation for 2 rate increases in 2019 — down from an expectation for 3 increases at the Committee's September's meeting — followed by 1 further increase in 2020 before reaching a pause in the tightening cycle. While appearing to be a 'dovish hike', the indication that the Committee will not pause tightening in 2019 clearly disappointed both interest rate and equity markets. That divergence in interest rate expectations has been a key factor in driving the volatility that has battered global markets over the past few months. Alongside concerns around a slowing global growth outlook and geopolitical and trade tensions, major equity markets across the US, European and Asian regions have now fallen by around 15% to 20% from their 2018 peaks.
Chart of the week
Over in Europe, there was a resolution to the months-long negotiations between the European Commission and Italy regarding their 2019 budget. Italy made concessions to lower their deficit target over the next three years, including a reduction from 2.4% of GDP to a little above 2% for 2019. The Commission assessed this to be an acceptable proposal and in the process ruled out imposing financial penalties on Italy.
Meanwhile, the Bank of England (BoE) noted in their latest policy meeting minutes that "Brexit uncertainties have intensified considerably since the Committee's last meeting". While this had resulted in financial conditions tightening and further declines for the Sterling and the domestic equity market, it had also impacted the real economy highlighted by a slower near-term growth outlook due to weakening business investment and a subdued household sector. The Bank made it clear that the outlook for the domestic economy was highly dependent on the nature of the withdrawal of the UK from the European Union.
— — —
There were several key developments in Australia this week. Firstly, the mid-year update to the federal budget showed that stronger-than-expected economic conditions from employment growth and commodity prices are forecast to boost the budget position by $31.3bn over the next 4 years, resulting in a greatly reduced deficit in 2018/19 of $5.2bn before a return to surplus of $4.1bn in 2019/20 (to read our full analysis see here).
Tuesday's Reserve Bank Board minutes from the December meeting appeared to take on a more cautious assessment of the domestic economy. The key discussion was around the household sector where the outlook for consumption "continued to be a source of uncertainty because growth in household income remained low, debt levels were high and housing prices had declined". The December Board meeting had occurred the day before the Q3 National Accounts were released, which would ultimately show that the domestic economy expanded by a slower-than-expected pace in the quarter weighed by a soft outturn from household expenditure (see our Q3 GDP review here). The Bank's central scenario is for strength in labour market conditions to support a gradual lift in wages growth to offset concerns around any potential negative wealth impacts.
Tuesday's Reserve Bank Board minutes from the December meeting appeared to take on a more cautious assessment of the domestic economy. The key discussion was around the household sector where the outlook for consumption "continued to be a source of uncertainty because growth in household income remained low, debt levels were high and housing prices had declined". The December Board meeting had occurred the day before the Q3 National Accounts were released, which would ultimately show that the domestic economy expanded by a slower-than-expected pace in the quarter weighed by a soft outturn from household expenditure (see our Q3 GDP review here). The Bank's central scenario is for strength in labour market conditions to support a gradual lift in wages growth to offset concerns around any potential negative wealth impacts.
On Wednesday, Australian banking regulator APRA announced that restrictions on interest-only residential mortgage lending will be removed from 1 January 2019 (see the media release here). The regulator introduced this measure in April last year, which had placed a cap on banks' interest-only lending at 30% of all new mortgages. This was in conjunction with an earlier measure introduced in late 2014 that had placed a 10% annual cap on the pace of housing credit growth to investors, though this restriction was unwound back in April this year.
According to APRA Chairman Wayne Byres, the removal of both restrictions had been justified as they had "served their purpose of moderating higher risk lending and supporting a gradual strengthening of lending standards". Last week, the Council of Financial Regulators — a group comprising the RBA, ASIC, APRA and Treasury — in their quarterly statement noted that "members discussed how an overly cautious approach by some lenders to incorporating relevant laws and standards into loan approval processes may be affecting lending decisions". This had followed recent comments from RBA Governor Philip Lowe expressing concern over the economic impact from the restrictive nature of credit standards.
APRA's decision during the week is aimed at addressing these concerns, however it is worth noting that when the regulator removed the 10% cap on investor borrowers earlier this year, credit growth to that segment continued to decline. Other factors to consider that could limit the impact of the removal of the cap on interest-only lending are; the strengthening of standards around loan serviceability criteria; declining property prices weakening demand for credit; and the upcoming report due to be tabled by the Royal Commission in February next year.
The highlight of the week was the labour force data for November that was released on Thursday (read our full analysis here). While the underlying detail within the report was broadly mixed, the key takeaway is that the nation's labour market remains in a solid state. This was headlined by employment increasing by 37,000 in the month — nearly double what the market had been expecting. The pace of employment growth has cleared slowed over 2018 but remains above growth in the working-age population, while forward-looking indicators from private surveys point to employment rising by around 20,000 per month — a level that that is broadly sufficient to prevent the nation's unemployment rate from rising. Participation in the workforce also increased further in November to be around record-high levels.
On the downside, the unemployment rate lifted slightly from 5.0% to 5.1%, though this likely reflected the rise in participation. Of more concern was an increase in measures of excess capacity, which are already at elevated levels and have been influential in restraining a faster pick up in the pace of wages growth. This remains a headwind to the household sector into 2019 and highlights the importance of robust conditions continuing in the nation's labour market.
According to APRA Chairman Wayne Byres, the removal of both restrictions had been justified as they had "served their purpose of moderating higher risk lending and supporting a gradual strengthening of lending standards". Last week, the Council of Financial Regulators — a group comprising the RBA, ASIC, APRA and Treasury — in their quarterly statement noted that "members discussed how an overly cautious approach by some lenders to incorporating relevant laws and standards into loan approval processes may be affecting lending decisions". This had followed recent comments from RBA Governor Philip Lowe expressing concern over the economic impact from the restrictive nature of credit standards.
APRA's decision during the week is aimed at addressing these concerns, however it is worth noting that when the regulator removed the 10% cap on investor borrowers earlier this year, credit growth to that segment continued to decline. Other factors to consider that could limit the impact of the removal of the cap on interest-only lending are; the strengthening of standards around loan serviceability criteria; declining property prices weakening demand for credit; and the upcoming report due to be tabled by the Royal Commission in February next year.
The highlight of the week was the labour force data for November that was released on Thursday (read our full analysis here). While the underlying detail within the report was broadly mixed, the key takeaway is that the nation's labour market remains in a solid state. This was headlined by employment increasing by 37,000 in the month — nearly double what the market had been expecting. The pace of employment growth has cleared slowed over 2018 but remains above growth in the working-age population, while forward-looking indicators from private surveys point to employment rising by around 20,000 per month — a level that that is broadly sufficient to prevent the nation's unemployment rate from rising. Participation in the workforce also increased further in November to be around record-high levels.
On the downside, the unemployment rate lifted slightly from 5.0% to 5.1%, though this likely reflected the rise in participation. Of more concern was an increase in measures of excess capacity, which are already at elevated levels and have been influential in restraining a faster pick up in the pace of wages growth. This remains a headwind to the household sector into 2019 and highlights the importance of robust conditions continuing in the nation's labour market.
— — —
With this our last note for 2018, I want to thank you all for reading my content this year. Your support is humbling given the vast amount of high-quality analysis that is widely available. Here, a special thanks must go to Pete Wargent who has been a big supporter of mine and I recommend you to follow his analysis. I write these posts because they reflect my passion for economics and the markets and they help me to keep track of developments, and I hope they have been useful to you. Please feel free to get in touch if you ever have any comments, feedback or questions.
James
Best wishes over the Christmas holidays and for 2019.
