Macro (Re)view (26/4) | RBA live after inflation decelerates

Amidst public holidays this week, Australian inflation data for the March quarter came in much slower than expected on both a headline and core basis. That prompted a significant re-pricing in markets; the probability of a 0.25% rate cut in May by the Reserve Bank of Australia (RBA) to 1.25% was increased to around a 50/50 chance, accelerating to 90% by June and is now fully priced for July. Yields on 2-year (around 1.33%) and 3-year bonds (around 1.29%) fell sharply inside the cash rate (1.5%) and the 10-year yield was cut by 11 basis points to around 1.8%.

Inflation according to the Consumer Price Index (CPI) stalled (0.0%) in Q1 slowing the annual rate to 1.3% from 1.8%, mainly due to a sharp fall in petrol prices while softness in rents and new dwelling costs was also notable. Some of that slowing is likely to reverse in Q2 in line with improving global oil prices, though more problematic from an RBA perspective is that core inflation also decelerated noticeably, indicating an easing in economy-wide pricing pressures. Core inflation in Q1 was very subdued at 0.19%, as annual growth turned down to a 2½-year low of 1.42% (For our full CPI analysis see here). Our chart of the week (below) highlights very clearly that core inflation has moved further away from the RBA's lower target of 2%. 

Chart of the week

  

In last week's review, we highlighted that the RBA's April meeting minutes mentioned the explicit scenario under which the Board would be prepared to cut the cash rate, the key line being "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". A face-value interpretation suggests that a deterioration in the unemployment rate is now all that stands in the way of a rate cut. On the other hand, a case could be made for a cut in May given the unambiguous weakness in the inflation data, particularly if the Board judges that "mixed" forward-looking labour market indicators are likely to result in slower employment growth in the months ahead. Price action in markets appears to indicate that the latter scenario is favoured, so we can consider the RBA's meetings from this point onwards to be 'live' for a rate cut to be announced. 

The RBA Board next meets on the 7/5 and three days later (10/5) the Bank is due to publish its quarterly Statement on Monetary Policy (SoMP), which outlines its detailed assessment of economic conditions and forecasts for growth and inflation. Looking at recent history, it might be of interest to note that each of the past 6 rate cuts announced by the Bank has been at a meeting that has directly preceded the release of its SoMP. Of those, 3 have occurred at a May meeting, 2 in August and 1 in February. 

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Central banks were also in focus globally this week, continuing the broad-based shift to more accommodative policy stances in response to the slowdown in global growth brought on mainly by trade tensions. On Thursday, the Bank of Japan (BoJ) held its ultra-stimulatory monetary policy settings in place, highlighting that it intends to maintain interest rates at their extremely low levels (policy rate -0.1% and 10-year bond yield around 0%) for at least the next 12 months. The BoJ also expected softer external demand to lower GDP growth slightly in 2019 to 0.8% compared with its previous forecast from January. 

Similarly, the Bank of Canada foresaw economic activity over the first half of 2019 slowing to 1.2% from its previous expectation for 1.7%, due to uncertainty over trade policy weighing on the export sector and on business investment combined with weakness in residential construction. That prompted the Bank's Governing Council to remove the wording in its statement around the timing of future interest rate increases. Also this week, the People's Bank of China (PBoC) announced it will inject around US$40bn of liquidity into the banking system, which is targeted at boosting lending for small and private businesses. Data last week showed that GDP growth in China firmed in Q1, providing an early sign that fiscal stimulus through tax cuts and infrastructure investment is beginning to take hold.

The highlight from abroad this week occurred on Friday as the 1st estimate of US GDP growth for Q1 accelerated to an annualised pace of 3.2% from 2.2% in Q4 of 2018, coming in much stronger than the market forecast for 2.3%. The acceleration in growth was driven mainly by a turnaround from net exports (+1.03ppt) and inventories (+0.65ppt); components that are typically volatile and likely accentuated by the ongoing trade tensions causing uncertainty for export and import-related businesses. It was a softer quarter for the consumer, with household consumption slowing noticeably from 2.5% to 1.2%, reflected by weakness in spending on new vehicles, clothing and footwear and household furnishings. Business investment also slowed sharply in Q1, with equipment almost stalling (0.2%) after rising by 6.6% in Q4, while spending on new structures contracted by 0.8%. The residential construction sector is an area of concern as activity declined by a further 2.8% in Q1, its 5th consecutive quarterly decline.