Macro (Re)view (7/6) | RBA cuts cash rate; Q1 GDP growth slows

Headlining the week domestically, the Reserve Bank of Australia (RBA) Board moved on its easing bias by cutting the official cash rate by 25 basis points (0.25%) to 1.25%. Governor Lowe outlined that the decision was taken in order to strengthen employment growth and, in turn, bolster confidence that inflation will gradually rise towards the 2-3% target range, rather than as a response to a deterioration in their economic outlook.    

The Bank's assessment is that Australia's level of 'full employment' is now consistent with an unemployment rate of around 4.5% -- a step lower than its historical estimate of around 5% and divergent from current conditions in the labour market following the rise in the unemployment rate from 5.1% to 5.2% in April. While the Bank retains a relatively constructive assessment on the labour market by highlighting strength in employment growth over the past year and gradually improving wages growth, an elevated level of excess capacity remains a restrictive influence. In acknowledgment, the Board resumed its easing cycle that commenced in November 2011, shown as our chart of the week (below), anticipating that a lower cash rate will help generate stronger labour market conditions and thereby shore-up its inflation outlook (see our full review here). 

Given the RBA's growth and inflation forecasts are based on the cash rate at 1.0%, at least one more rate cut can be expected in 2019, though financial markets are pricing in around 40 basis points of cuts. Importantly, Governor Lowe again reiterated the limitations of monetary policy in isolation and called for additional support from both the fiscal and structural sides.   

Chart of the week

The other major development locally this week was Q1's National Accounts, which showed that GDP growth was softer than expected in the quarter at 0.4% as annual growth slowed to 1.8% -- its lowest in 9½ years and around 1ppt below trend or potential growth of 2.75% (see our full review here). The key themes were; further slowing in household consumption growth reflecting persistent weakness in income growth and wealth impacts from falling property prices, an intensification of the downturn in the residential construction cycle, and subdued business investment.

Weakness in private sector demand remains in contrast with strong public demand, which is broadly based across consumption spending relating to the rollout of health and aged care initiatives, and investment in infrastructure projects in response to robust population growth. International trade was also supportive of growth in Q1 reversing a weak Q4 following supply disruptions in the resources sector. Also of significance is the tailwind from surging commodity prices that is bolstering national income growth and will provide the federal government with increased scope for fiscal stimulus in a slowing economy.  

There were a number of other data updates out this week for the month of April, including a decline in retail spending centred on discretionary consumption (see here), another highly elevated trade surplus driven by iron ore exports (covered here) and further weakness in housing finance approvals, though pre-dated by the federal election outcome and other supportive developments (reviewed here). Meanwhile, CoreLogic's Home Value Index showed that the national median price fell by 0.4% in May and by 7.3% over the year, though the pace of decline is slowing (see here).  

  

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Turning to offshore developments, central banks featured prominently this week with policymakers delivering assurances of support to nervous financial markets unsettled by the recent escalation in trade tensions. In the US, there has been a shift in the tone of the rhetoric from the Federal Reserve away from their recent "patient" narrative given the uncertainties to the growth outlook posed by trade tensions. Notably, in a speech Fed Chair Powell highlighted that given the prevailing risks, the Committee stands ready to "act as appropriate to sustain the (economic) expansion". Similar sentiments were expressed by Fed Vice Chair Clarida last week that pointed to the Committee being responsive to persistently low inflation or to a deterioration in economic conditions. Friday's soft US employment report where non-farm payrolls lifted by 75,000 in May -- well short of the 175,000 expected -- only intensified expectations in financial markets for a near-term rate cut.    

Over in Europe, the European Central Bank conducted its latest policy, where due to the "prolonged presence of uncertainties" associated with trade tensions, geopolitical developments, and emerging market vulnerabilities the Governing Council is "determined to act" to support the economy -- including potentially restarting its asset purchase programme.  

The Bank's outlook for GDP growth was revised up to 1.2% in 2019 (+0.1ppt), though there were downgrades for 2020 to 1.4% (-0.2ppt) and 2021 to 1.4% (-0.1ppt). Similarly, inflation is forecast to reach 1.3% in 2019 (+0.1ppt) but lowers to 1.4% in 2020 (-0.1ppt) before rising to 1.6% in 2021 (unchanged). With the risks described by ECB President Draghi as "tilted to the downside", the Bank's forward guidance for an interest rate increase was pushed back by 6 months to at least the end of the first half of 2020. 

Also announced were pricing details of the ECB's upcoming TLTRO-III series (a form of funding to the banking sector). Though within expectations, markets were left somewhat underwhelmed given this iteration will be priced slightly less favourably than the version it will replace. Adding to the disappointment, it appears that plans for 'tiering' the negative deposit rate charged on banks' excess reserves have been shelved for the time being.