Independent Australian and global macro analysis

Friday, May 24, 2019

Macro (Re)view (24/5) | RBA to announce June rate cut

The Reserve Bank of Australia (RBA) is almost certain to deliver a rate cut at its June Board meeting, with an additional 25 basis points of easing fully priced in by the end of the year. The decision to remain on hold at 1.5% at May was finely balanced, with the minutes from the meeting released this week signaling the Board's shift to an easing bias, which was later confirmed by RBA Governor Philip Lowe following a speech in Brisbane.  

Both the minutes and Governor Lowe's speech conveyed that the risks to the domestic economy are to the downside given the headwinds from abroad posed by a slowdown in China and renewed trade tensions and a weaker consumer at home. It is also clear that the sharp slowing in inflation in Q1 (reviewed here) surprised the Bank. For some time the RBA has been buoyed by robust labour market conditions, expecting that spare capacity would gradually be eroded, in turn generating faster wages growth to drive inflation back to target. However, with the headwinds strengthening and with inflation stuck below target since Q1 2016, the recent signs from April's labour market data that conditions are softening (see herewill seal the case for the Board to make its move in June.   

During his speech, Governor Lowe highlighted that Australia can now sustain an unemployment rate below its historical estimate of around 5% without generating capacity and inflationary concerns. To achieve that outcome, the Bank's strategy will be to lower the cash rate, which according to markets will fall to 1.0% by end 2019, to spur on employment growth and drive and earlier return of inflation back to target. Importantly, though, Governor Lowe pointed out that "relying on just one type of policy has limitations" and called for increased fiscal support and structural policies targeted at boosting the nation's productive capacity. 

On that front, the re-elected Coalition government will set its sights on implementing its tax relief measures from April's Budget (see here), though the full scale of its planned increase to the low and middle-income tax offset will be delayed until the new parliament can be convened. Also this week, banking regulator APRA announced a proposal to lower its long-standing serviceability requirement for home loan assessments from a minimum of at least 7.0% to buffer of 2.5% above the prevailing interest rate (see here). The proposal is intended to address concerns around overly restrictive lending criteria amid the ongoing correction in the housing market and will now go through a consultation phase ending mid next month before a final decision is reached shortly thereafter.

Data this week showed construction activity slid by 1.9% in Q1 (reviewed here), with activity in the residential sector continuing to deteriorate (see chart below), while public infrastructure work was also surprisingly weak. In better news, the Commonwealth Bank IHS Markit Composite Purchasing Managers' Index showed activity by the nation's business sector expanded in May to a reading of 52.2 in May — its first expansionary result in 4 months — driven mostly by the services sector with modest support from manufacturing. With uncertainty over the outcome of the federal election consigned to the past and stimulus to come from rate cuts and tax relief, this may have further to run. 

Chart of the week

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Politics and central banks led the headlines offshore this week, while US-China trade tensions continued to escalate hitting tech firms in both countries. Starting in the US, the minutes from the Federal Reserve's meeting from April and May were released showing that the Committee anticipated that their patient approach to monetary policy settings "would likely remain appropriate for some time". That stands in direct contrast to expectations in financial markets for two rate cuts over the next 12 months, in part prompted by slowing inflation, however in the Committee's view that is likely to prove "transitory". While economic growth was expected to moderate from Q1's strong 3.2% pace, the outlook is still constructive given the household sector is robust due to a strong labour market, increasing wages growth and positive sentiment. Committee members' views around business investment were decidedly mixed; easier financial conditions were supportive but concerns around trade and slower global growth were likely to be dampening sentiment. Overall, the Committee remains optimistic but notes that uncertainty around the global growth outlook, geopolitical and trade developments combined with subdued inflation warranted its patient policy approach. 

In Europe, the account of the European Central Bank's policy meeting in early April showed that the Governing Council acknowledged the loss of momentum in economic growth evident over the second half of 2018 had continued into the new year. Activity was expected to pick-up later on in 2019, albeit with risks to the downside due to trade and geopolitical uncertainty from abroad. Those concerns are somewhat moderated by a strengthening labour market and rising wages growth, which was expected to gradually drive the inflationary pulse. Though details of the upcoming TLTRO-III (a source of cheap funding to the banking sector) are yet to be finalised, April's account showed a general agreement that pricing should reflect underlying economic conditions as well as the effectiveness of transmission into the real economy.

Over in the UK, after a tumultuous week and following the loss of the support of key Conservatives, PM Theresa May announced her resignation effective on June 7. The announcement came amid the European Parliamentary elections, where in the UK the Nigel Farage-led Brexit Party (campaigning for a no-deal Brexit) is expected to come out on top according to the polls.