Macro (Re)view (7/2) | RBA maintains constructive outlook

Events domestically this week were focused on the latest communication from the Reserve Bank of Australia (RBA), which was the first time markets have heard from the Bank in 2020. On Tuesday, the Board elected to hold the cash rate steady at 0.75%, as expected (see here), but the decision statement conveyed optimism over both the domestic and global economic outlook in spite of Australia's summer bushfires and the outbreak of the coronavirus. With data over the inter-meeting period showing a decline in the nation's unemployment rate from 5.3% to 5.1% and an underlying inflation print of 1.6%yr in Q4 that matched the Bank's forecasts, the Board received sufficient justification to continue its wait-and-see approach on policy settings, noting that the "long and variable lags" associated with last year's rate cuts (in June, July and October) meant that their transmission into the real economy was still ongoing, but identified a lower exchange rate and improvements in household balance sheets as signs easier monetary policy was gaining traction. However, with the unemployment rate expected to remain above the 4.5% level estimated by the RBA to be consistent with full employment over the next couple of years, the decision statement retained the Board's easing bias.   

On Wednesday, RBA Governor Philip Lowe gave an address to the National Press Club (titled: 'The Year Ahead') that appeared to indicate the threshold for the Board to act further on that easing bias had risen. Governor Lowe explained that while the cash rate could be lowered further in an attempt to speed up employment growth and inflation, there were now seen to be offsetting risks posed to financial stability through additional leverage at a time when house prices are in an upswing and for consumer confidence to deteriorate more rapidly from such an action. Where that balance would tilt in favour of more easing would be in the event that the "unemployment rate were to be trending higher and there was no further progress being made towards the inflation target" Governor Lowe said. That was a message reiterated by the governor during the Bank's semi-annual appearance before the House of Representatives' Standing Committee on Economics on Friday (Hansard here), as was the view that unconventional policies in the form of quantitative easing and negative rates were not expected to be required. 

To round out the week, the Bank published its quarterly Statement on Monetary Policy and updated economic forecasts in which it maintained its constructive view on the outlook for domestic growth to pick from its below-trend pace of the past year or so (current pace is 1.7%Y/Y as of Q3 2019) to trend (2.75%) by the end of 2020 and then rise a little further to 3.0% in 2021 (see chart of the week, below). The bushfires and coronavirus are seen as having a short-term transitory impact on growth concentrated in the first half of the year, with the outlook downgraded from a 2.6% pace to 1.9% before recovering over the second half of the year through rebuilding efforts and activity returning to normal. Certainly, the market has viewed this outlook as optimistic, and while the RBA acknowledges the uncertainties both domestically and offshore are material, it contends the fundamentals are strong.

Chart of week 

The RBA's forecast for growth to pick up over 2020 is predicated on more a constructive global growth impulse in line with receding trade tensions and a stabilisation of the downturn in the manufacturing sector. Domestically, the key is consumption growth improving on household balance sheets bolstered by earlier rate cuts that have lowered debt servicing costs and boosted house prices, with data from CoreLogic this week confirming the upswing in national dwelling prices was running at its fastest pace in more than 2 years at 4.1% through the year to January. Accordingly, the RBA will have welcomed this week's data that showed retail sales volumes lifted by a stronger-than-expected 0.5% in the December quarter, though as discussed here this was likely was boosted by Black Friday sales.

While the ongoing downturn in residential construction activity has the Bank anticipating it to remain a drag on overall growth over coming quarters, improving dwelling approvals data, including this week's broadly stable update for December (see here), has prompted a shift to a more sanguine outlook where the cycle turns later this year. Meanwhile, a mining sector-led pick up in capital expenditure following 7 years of decline is expected to support a 9.3% rise in business investment through 2020. Based on this week's international trade data for December, indications are that net exports will contribute modestly to economic growth in Q4 (see here), though the RBA expects the export sector to be affected notably by the bushfires and coronavirus through reduced education-and holiday-related tourism.

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Switching the focus offshore, Chinese markets came back online this week after Lunar New Year holidays resulting in local equities catching down in response to the coronavirus outbreak, however liquidity-injecting measures from the People's Bank of China helped keep fears in global markets contained. Also in China, authorities announced a halving of imports tariffs on $75bn of US-produced goods, with levies to fall on February 14 from 10% to 5% and from 5% to 2.5% depending on the goods in question, in a response that reciprocates commitments made by the US under the phase one trade deal. The highlight of the week came on Friday where data confirmed the US labour market remained robust at the start of the year as non-farm payrolls advanced by 225k in January to outperform expectations for a 165k rise. The unemployment rate edged up from 3.5% to 3.6% and underemployment retraced its decline from December in rising from 6.7% to 6.9%, though that in part reflected a 0.2ppt lift in the participation rate to 62.4%, while annual revisions resulted in employment gains being lowered by 514k through the year to March 2019. Growth in average hourly earnings also surprised to the upside firming from 3.0% to 3.1% year on year. In another positive sign for the US economy, activity in the manufacturing sector expanded for the first time in 6 months in January as the ISM index improved by 3.1pts to 50.9, well clear of the 48.5 level expected. This was driven by positive swings in the month from new orders (+4.4pts) and production (+9.5pts), though this is yet to reflect coronavirus-related impacts. Meanwhile, conditions for services firms remained robust in January as the ISM non-manufacturing index recorded a 0.6pt lift to 55.5 completing a decade of continuous expansion of activity in the sector. 

In Europe, the growth impulse showed signs of improvement at the start of the year, though the risk is that this recovery is derailed by the coronavirus given the bloc's high exposure to the global economy through its key export sector. For the moment, Markit's Composite Purchasing Managers' Index showed activity in the euro area economy improved to its strongest in 5 months rising from 50.9 to 51.3 in January. There were continued signs of stabilisation of the downturn in the manufacturing cycle, with activity in the sector still in contraction but on the rise from 46.3 to 47.9 in January according to the Markit Manufacturing PMI. Against the manufacturing rollover, Europe's services sector has remained resilient, though Markit reported activity softened a touch in January from 52.8 to 52.5 due to underperformance in France and Spain. On the consumer front, retail sales volumes pulled back by -1.6% in December after a 0.8% lift in November, slowing the annual pace from 2.3% to a subdued 1.3%. Meanwhile, Europe Central Bank President Christine Lagarde told a parliamtentary hearing this week that structural weakness in the bloc from slow productivity and ageing demographics had contributed in driving interest rates to their very low levels, in turn limiting its and other central banks' scope to respond to economic downturns through easier monetary policy settings.