Australian housing finance approvals gathering momentum

Australian housing finance approvals lifted further in August, while the value of lending commitments lifted for the 3rd straight month in both the owner-occupier and investor segments. Overall, the report was consistent with the recent improvement in housing market activity, which is also evident in a range of other indicators. 

Housing Finance — August | By the numbers

• Owner-occupier housing finance approvals (excluding refinancing) lifted by 0.7% in August to 32,740 (seasonally adjusted), though this was below the 2.3% rise forecast by markets (prior rev: +4.4% from +4.2%). The decline in annual terms slowed to -5.1% from -8.4% (revised from -8.7%). 

• The total value of housing finance commitments (excluding refinancing) increased by 2.9% in August to $A18.438bn (prior: +5.1%) to be down by 5.0% through the year (prior rev: -11.7%)

Housing Finance — August | The details 

Total lending commitments by value (excluding refinancing) increased for the third straight month in August with a 2.9% rise to $18.438bn. This is 5.0% down on the level from a year earlier, though this pace of contraction was improved from -11.7%Y/Y in July and is now at its slowest rate since February 2018.

Looking at the segments, for the third straight month commitments to both owner-occupiers and investors increased. Owner-occupier commitments lifted by 1.9% to $13.555bn to be down by just 1.7% through the year compared to -7.9% in July. Investor commitments posted their strongest monthly rise in nearly 3 years with a 5.7% lift in August to $4.884bn, which is -13.0% on a year earlier but improved from the -21.2% contraction in July. Elsewhere, the value of approvals made for alterations to existing owner-occupied properties increased by 5.4% in August to $284.8m to be near-flat over the year (-0.1%) having improved from a 9.0% contraction year-on-year to July.

Refinancing commitments remain on the rise following a 7.7% increase in August to $9.436bn and is running at a 5.7% pace through the year — its strongest since July 2018. Owner-occupier refinancing was up by 8.4% in the month to $6.709bn to be 4.5% above the level from a year earlier, while investor refinancing elevated by 6.1% in August to $2.728bn and is up by 8.7% year-on-year — its fastest since April last year. 

Turning to owner-occupier loan approvals, the total number (excluding refinancing) lifted for the 4th straight month in August rising by 0.7% to 32,740. In annual terms, the contraction slowed from -8.4% to -5.1% to be at its slowest pace since June last year. Approvals to purchase established dwellings firmed by 0.6% to 25,088 (-4.3%Y/Y), while construction-related approvals lifted by 1.1% to 7,652 (-7.7%Y/Y). Within the latter, loan approvals to purchase newly constructed dwellings (including from off the plan) lifted by 2.7% to build on an 8.7% rise in July, with the annual contraction slowing from -10.2% to -7.4%, while loans to fund new construction were up by 0.3% to August to 5,253 (-7.9%Y/Y). The ABS does not produce approval estimates for the investor segment. 

    

The state-by-state breakdown of approvals and commitments is provided in the table, below. 

The national rise of 0.7% in owner-occupier approvals was outpaced by a majority of states; Queensland (2.3%), New South Wales (2.1%), South Australia (1.9%) and Victoria (1.5%).

In the investor segment, activity looks to be picking up across the board, though it is still early days on this front. Notwithstanding, there were strong rises for the 2nd straight month in Victoria (9.5%), Queensland (10.4%) and Tasmania (9.8%).  

Housing Finance — August | Insights 

Today's report indicated that momentum in housing finance continues to gather pace with uncertainty over the federal election outcome and potential changes in tax policy now well and truly in the past, while recent RBA rate cuts and APRA's easing in guidance round credit assessment standards also appear to be having some impact. Reflecting this, attitudes towards house price expectations remain strongly on the rise according to the details from yesterday's Westpac-Melbourne Institue Index of Consumer Sentiment, though on the other hand there appears to be renewed concerns over affordability, particularly in New South Wales and Victoria.  

Macro (Re)view (4/10) | RBA cuts again as global sentiment weakens

In a widely anticipated call, the Reserve Bank of Australia cut the cash rate by 25 basis points this week to 0.75%. Since recommencing their easing cycle in June, the Board has cut by a total of 75 basis points to recalibrate policy to a domestic economy operating well below capacity and to keep pace with the global shift to more accommodative stances from other central banks as concerns over the growth outlook intensify. Tuesday's statement by Governor Philip Lowe highlighted that the decision to cut in October was taken to "support employment and income growth and to provide greater confidence that inflation will be consistent with the medium-term target" while also acknowledging "the trend to lower interest rates globally" given its impact on domestic growth and inflation (see our full review here).

In the 4 weeks since its previous meeting, there were a number of key developments offshore and domestically that factored into the Board cutting in October. Offshore, the US Federal Reserve and European Central Bank eased their respective monetary policy settings prompted by downside risks to the global economic outlook due to the ongoing trade and geopolitical tensions, and soft inflation pressures. Domestically, Q2's national accounts showed GDP growth had slowed from 1.8% to 1.4% year-on-year and was described as a "weaker-than-expected outcome", though the governor reiterated his assessment from last week, which was that he sees the economy may be at a "gentle turning point" given the stimulus from lower rates and tax cuts and a stabilising housing market. Clearly, much of this depends on the consumer — an ongoing source of uncertainty for the Bank — and retail sales data for August released during the week showed a 0.4% increase in the month (shown as our chart of the week, below), indicating only modest flow-through to date from the monetary and fiscal stimulus measures (see here).      

Chart of the week 

In looking ahead, the Board retains an explicit easing bias by noting that it is: "prepared to ease monetary policy further if needed to support sustainable growth in the economy, full employment and the achievement of the inflation target over time". The key here is the description of "full employment", which compares to the more modest objective of "reducing unemployment" used in the previous statement. Full employment has always been part of the RBA's mandate, though it perhaps provides some indication of the Bank's commitment to move to the necessary policy stance to achieve this objective, which is seen as key to returning inflation sustainably to within the 2-3% target band. Market pricing indicates a cut at the next meeting in November as around a 50/50 chance, though the domestic data flow and events offshore will be key in shifting this in either direction.

Also from the RBA this week was the release of its bi-annual Financial Stability Review. Despite noting the risks posed by external shocks, high household debt and from the housing market, the Bank appears sanguine by highlighting the system's improved resilience as a result of the implementation of post-GFC reforms. In particular, risks from the housing market appear to have receded somewhat given that house prices appear to be gathering momentum with a 0.9% rise on a national basis in September according to data released by CoreLogic this week (see here). However, risks from price acceleration could re-emerge down the track due to supply constraints with population growth expected to remain strong amid the ongoing deterioration in dwelling approvals, which this week showed a further 1.1% fall in August to a 6½-year low (see here). Lastly, the other point of note this week was an easing in the nation's monthly trade surplus from its second-highest on record at $7.25bn to a still highly elevated $5.9bn in August reflecting declines in iron ore prices (see here).

— — — 

Turning to events offshore where sentiment deteriorated on further signs of weakness in the global economy. This continues to be led by a manufacturing sector that remains in contraction on a global basis, though there were increasing signs that this is now spilling over into the broader services sector. In the US, the closely followed ISM manufacturing index slumped to a decade-low reading of 47.8 in September from 49.1, indicating a much faster contraction is now occurring in the sector that accounts for around 11% of national economic output. The main feature of the report underscored the impact of trade tensions and a weaker global economy, with new export orders sliding to their lowest level since March 2009, as demand-side concerns saw firms downwardly adjusting their inventory positions. Later in the week, the ISM non-manufacturing index showed the services sector remains in expansion at 52.6 in September, though that was slower than expected and down from 56.4 in the previous month. This was driven by slowing levels of activity, new orders, and employment, but all three are still rising. 

On employment, Friday's non-farm payrolls report contained mixed details with 136k jobs added in September compared to the consensus for 145k, while August's initially reported increase of 130k was revised up to 168k. Employment growth has clearly been slowing this year, with the annual pace now at 1.44% compared to 1.82% at the end of 2018, though the labour market is tight. The unemployment rate unexpectedly fell from 3.7% to 3.5% — its lowest since  1969 — and underutilisation, which includes unemployment and underemployment, fell from 7.2% to 6.9% — its lowest since 2000. This was despite the participation rate remaining unchanged at 62.3%. Somewhat strangely, annual growth in average hourly earnings slid to its slowest in more than a year; from 3.2% to 2.9%, though this can be a volatile measure. Markets saw enough in the data flow this week to move towards pricing in two more rate cuts before year's end. This was helped by comments from the Chicago Federal Reserve President Charles Evans that he was "open-minded" about adjusting rates as needed, though Vice-Chair of the Committee Richard Clarida was more measured in his remarks this week. 

Over in Europe, Markit's PMI of manufacturing activity in the bloc contracted further in September to its weakest in 7 years at a reading of 45.7 from 47.0. Most notably, the contraction in Germany intensified to a 10-year low of 41.7 compared to 43.5 in August, highlighted by renewed weakness in new orders and employment. Though still resilient, activity in the Eurozone's services sector is slowing, with Markit's PMI falling from 53.5 to 51.6 to be at its weakest since the beginning of the year. Taken together, the ongoing contraction in manufacturing and slowing in services sector activity pointed to an economy close to stalling from its pace in Q2 0.2% and 1.2% year-on-year. During a speech in Athens this week, European Central Bank President Mario Draghi reiterated that the Governing Council's recent stimulus measures demonstrated their commitment to respond to a weakening growth and inflation outlook, though the effectiveness of those actions would be enhanced by a greater contribution from fiscal policy.  

Australian retail sales rise 0.4% in August

Australian retail turnover lifted by a softer-than-expected 0.4% in August, indicating only modest flow-through from recent monetary and fiscal stimulus measures. The detail for discretionary retail was improved on a weak outcome in July.  

Retail Sales — August | By the numbers

• National turnover lifted by 0.4% in the month on a seasonally adjusted basis to $A27.546bn, which slightly missed the median forecast for a 0.5% rise. Last month's initially reported a contraction of 0.1% was revised to a flat (0.0%) outcome. 

• In annual terms to August, retail turnover lifted to 2.6% from 2.4%. 
• Turnover growth in trend terms increased by 0.1% in August, while the annual pace continued to soften moving down from 2.5% to 2.3% — its weakest since December 2017. 

Retail Sales — August | The details 

In light of the recent rate cuts from the Reserve Bank of Australia and the increased tax relief for low-and middle-income earners from the Federal government, the breakdown of spending August is worth taking a close look at. Overall, the headline increase was 0.4%, which was the strongest monthly outcome since February earlier this year, while the annual pace lifted to 2.6% to be back where it was around April and May. Excluding food (around 40% of total turnover), spending lifted by 0.5% in August to be up by 1.9% through the year. This was led by clothing and footwear at 1.8% (4.9%Y/Y) and department stores up by 1.1% (1.7%Y/Y). However, the increases in household goods of 0.3% (0.8%Y/Y) and other goods at 0.3% (2.5%Y/Y) were modest. Meanwhile, spending in cafes and restaurants contracted by 0.3% in the month (1.0%Y/Y). Food retailing increased by 0.4% (3.6%Y/Y) matching the outcome from July. All considered, there was a slightly better tone to discretionary retail in August, though that follows a weak July where sales ex-food fell by 0.3%. 

   

Across the states, turnover growth was generally up modestly in August. This was led by Queensland 0.8% (5.1%Y/Y), followed by South Australia 0.6% (2.0%Y/Y). Spending in the two largest states of New South Wales and Victoria increased by 0.3%, though in annual terms it is a vastly different picture, with Victoria running at 3.5% compared to just 0.3% in New South Wales. Turnover lifted by 0.2% in Tasmania for the month (1.7%Y/Y), while Western Australia saw a contraction of 0.1% (2.8%Y/Y). 

  

Online retail spending lifted by 2.9% in August to be up by 12.8% over the year according to the ABS's estimates. As a percentage of total retail turnover, the online space ticked up from 6.1% to 6.2%.  

Retail Sales — August | Insights

There was a modest boost to retail spending in August pointing to some flow-through from recent monetary and fiscal stimulus measures. However, it still appears to be too early to assess this impact, and it also needs to be put in the context of a weak outcome in July. Spare capacity in the labour market and low income growth, as well as soft consumer sentiment, remain headwinds to the outlook household consumption growth. 

Australia's trade surplus eases to $5.9bn in August

Australia's trade balance pulled back to $5.9bn in August after posting its second-highest monthly surplus on record in July in line with declines in iron ore prices. Export earnings sustained a 3.4% hit in August as a result, while weak domestic demand conditions and a weakening Australian dollar remained a headwind for imports. 

International Trade — August | By the numbers

• The nation's trade surplus weakened by $1.327bn in August to $A5.926bn to come in slightly below the median forecast of $6.0bn. July's trade surplus was revised down to $7.253bn from the $7.268bn total initially reported by the ABS.
• Export earnings fell by 3.4% in August (-$1.464bn) to $40.982bn, slowing the annual pace of growth to 10.1% (prior rev: +0.4%m/m, +15.6%Y/Y) 
• Import spending softened by 0.4% in the month (-$137m) to $35.056bn to be virtually flat over the year at 0.2% (prior rev: +2.5%m/m, +0.7%Y/Y)

International Trade — August | The details 

Export earnings fell by $1.464bn ($A nominal terms) or by 3.4% in August to $40.982m; taking it back to its level of April-May. By percentage terms, this was the sharpest monthly contraction since April 2017, and while the annual pace was still strong at 10.1% it slowed noticeably from 15.6% last month. Leading the decline was the non-rural goods category with a 3.5% fall (-$971m). In the main, this reflected the impact of a weakening in iron ore prices with earnings from metal ores and minerals down by 10% (-$1.217bn). For the other major commodities, coal exports fell by 4% (-$241m) and other mineral fuels (including LNG) lifted by 10% ($470m). Despite the impact of drought conditions, rural goods lifted by 1.4% (+$51m) to slightly offset last month's decline, though earnings are down by 9.6% on a year earlier. A 65.8% surge in volatile non-monetary gold exports in July was only partially unwound in August, declining by 22.0% (-$601m). Services exports firmed by 0.6% in August (+$53m) to be up 6.9% through the year, with inbound tourism contributing the bulk (+39m) of this increase.        

On the import side, August's bill fell by 0.4% or $137m on the previous month to $35.056bn. From a year earlier, import expenditure is up by just 0.2% dampened by the pass-through from an Australian dollar that declined in the order of 7.7% against the US dollar over this time. However, weak private sector demand conditions are also key, as highlighted by the recent national accounts for Q2 (see here). August's decline was consistent with this theme, with capital goods down by 1.9% (-$115m) and consumption goods falling by 0.9% (-$76m). Annual growth in capital goods has fallen to -11.9% from 13.3% a year ago, while for consumption goods the pace is 0.7% from 6.9% in August 2018. Intermediate goods posted a 3.8% fall in the month (-$424m) that was mainly attributable to a 7% slide ($-241m) from fuels and lubricants reflecting weaker prices. Service imports lifted by 1.9% in August ($164m) led by maintenance and repairs. 

   

International Trade — August | Insights 

The market was accurate in its forecast for the trade surplus to moderate to the vicinity of $6bn reflecting the impact of declining iron ore prices. Since August's lows, iron ore prices recovered slightly over September. Next month's trade surplus might be on track for an outcome similar to today's. Commodity exports are still running at highly elevated levels, while weakness continues to be evident in imports. Net exports added 0.6ppt to activity in Q2 and at this stage appear likely to make another solid contribution in Q3.

RBA cuts the cash rate by 25bps to 0.75%

The Reserve Bank of Australia (RBA) Board cut the cash rate by 25 basis points to 0.75% at its meeting in Melbourne today. This decision had to a large extent been discounted by markets and was also the consensus forecast of economists based on official surveys. The Board recommenced its easing cycle with back-to-back rate cuts in June and July and has now opted to cut again after holding steady at the August and September meetings.

The decision statement from Governor Philip Lowe outlined that the basis of today's rate cut was "to support employment and income growth and to provide greater confidence that inflation will be consistent with the medium-term target". Also, as the governor foreshadowed during his speech in regional New South Wales last week, influences from offshore were also key to the decision to cut at this meeting. 

Over the past few months, the Board has become notably more cautious in its commentary around global economic conditions and today's decision statement was reflective of this theme. In particular, the governor noted that the risks to the outlook for global growth "are tilted to the downside" and were linked to the tensions between the US and China, causing international trade volumes to weaken and firms to scale back their investment intentions amid the prevailing uncertainty. These factors were key to the decisions by US Federal Reserve and European Central Bank to ease their respective policy stances recently. Acknowledging these actions, the governor noted: "The Board also took account of the forces leading to the trend to lower interest rates globally and the effects this trend is having on the Australian economy and inflation outcomes". In last week's speech, the governor highlighted that if domestic policy was to be resistant to the global shift to lower rates: "our exchange rate would appreciate, which, in the current environment, would be unhelpful in terms of achieving both the inflation target and full employment".

From a domestic viewpoint, Q2's GDP growth outcome of 1.4% in annual terms was acknowledged as a "weaker-than-expected outcome", which potentially opens the door for a downgrade to its outlook in next month's quarterly statement. However, in keeping with the description he used last week, the governor again notes the economy may be at a "gentle turning point" given the support from lower interest rates, tax cuts, infrastructure spending, signs of stabilisation in the major housing markets and a more buoyant resources sector. Caution attends that outlook given prospects for household consumption growth are uncertain, with "the sustained period of only modest increases in household disposable income continuing to weigh on consumer spending". 

The key focus remains around the labour market and the outlook for wages growth. While strong employment growth was noted, the governor expects the pace to slow given the signals coming from forward-looking indicators, and also highlighted that the unemployment rate has "remained steady at around 5¼ per cent over recent months". Recall that the Bank estimates full employment to be consistent with an unemployment rate of around 4.5%. Keeping pace with robust employment growth has been participation in the workforce and as such: "Wages growth remains subdued and there is little upward pressure at present". With that being the case, the governor's outlook for inflation remained unchanged, with the headline and core measures anticipated to be "a little under 2 per cent over 2020 and a little above 2 per cent over 2021". 

The concluding paragraph emphasises that further easing in the policy stance will be considered should it assess that it is warranted, either by events offshore or with respect to achieving its objectives: "The Board will continue to monitor developments, including in the labour market, and is prepared to ease monetary policy further if needed to support sustainable growth in the economy, full employment and the achievement of the inflation target over time".

— — —

Following today's meeting, Governor Lowe delivered a speech at the RBA's Melbourne Board meeting dinner with the business community. In explaining the decsion from earlier this afternoon, he noted: "We are seeking to make more assured progress towards both full employment and the inflation target. We still expect to make progress on both fronts, but that progress is slower than we would like. Today's decision will help". The governor also reiterated his message around the global shift to lower interest rates and the implications for Australia, as well as subdued inflation pressures influenced by spare capacity in the labour market. A persistent theme of the governor's Q&A session following his speech last week was around the importance of providing businesses with the framework that will encourage expansion, investment, innovation and hiring. To assist with this, Governor Lowe suggested a renewed focus could be centred on structural reform to enhance productivity growth.  

Australian dwelling approvals fall 1.1% in August

Australian dwelling approvals took another step lower with a 1.1% decline in August to be at their lowest level in 6½ years. Both house and unit approvals have fallen heavily over the past year and point to ongoing weakness in residential construction activity.   

Building Approvals — August | By the numbers

• Total dwelling approvals (including the private and public sectors) on a seasonally adjusted basis fell by 1.1% in August to 12,817 disappointing the median forecast for a 2% rise. In the previous month, approvals fell by a sizeable 9.7%. 

• Approvals over the past year are down by 21.5%, slowing from a 28.2% decline in July.
• Unit approvals increased by 1.5% in August to 4,674, which follows a volatile 19.7% fall in the previous month. The pace of decline over the past year now stands at -28.2% compared to -43.3% in July.

• House approvals fell by 2.6% in the month (prior rev: -2.9%) to 8,143 to be down by 17.1% through the year (prior rev -16.0%).
• On a trend basis, total dwelling approvals fell by 3.9% in August to be down by 25.6% year-on-year, with houses -1.0%m/m and -15.8%Y/Y and units -8.9%m/m and -38.5%Y/Y.

Building Approvals — August | The details 

The total level of dwelling approvals fell to a 6½-year low after taking a further step lower in August. House approvals at around 8,100 are at their lowest level since early 2013, while unit approvals have retraced to the level that prevailed around early 2012. In trend terms, the recent peak in total approvals came in late 2017 (November to be precise) at around 19,900. Thus, the decline from the peak currently stands at 35.3%. A similar analysis has house approvals down by 20.8% from their early-2018 peak, while unit approvals have halved (-52.4%) from their most recent peak in late 2017. Given the recent weakness in approvals, it is likely that a stabilisation is still a number of months away and appears unlikely to occur before Q1 next year.

 

The monthly state details were again highly volatile, with New South Wales leading with a 10.6% rise followed by Victoria (+6.5%), Tasmania (+4.4%) and Western Australia (+4.2%). However, there were sizeable declines in Queensland (-21.4%) and South Australia (-29.7%). In trend terms, approvals growth over the past remain heavily negative in all states as per the chart, below. 

Lastly, the value of alteration work to existing residential properties fell by 4.5% in the month to $689.1m (-0.3%Y/Y). The value of non-residential work approved, which is a volatile series, surged in August (+54%) to $6.1bn continuing its recent uptrend. 

Building Approvals — August | Insights 

This was another weak update for building approvals that extends the run of negative annual growth out to 14 months. As such, residential construction activity is likely to remain a headwind to economic growth over the remainder of 2019 and then into 2020. 

Preview: RBA October meeting

The Reserve Bank of Australia (RBA) Board is on the road for its latest policy meeting that takes place in the Victorian state capital of Melbourne today. Since the Board lowered the cash rate in June and July to 1.00%, it has been on hold at the two meetings that have followed. At 2:30PM AEST, the Board is expected to announce another 25 basis point cut lowering the cash rate to 0.75%.     

The minutes from September's meeting contained a similar theme from the previous month, indicating the Board is closely monitoring an increasingly uncertain economic outlook offshore and a domestic economy operating well below capacity. Since cutting in June and July, the Board had used the ensuing period to assess the impact on the data flow. September's minutes indicated the threshold to cut again was close: "Taken together, recent outcomes suggested that spare capacity remained in the labour market and that the Australian economy could sustain lower rates of unemployment and underemployment".  

This was essentially the reasoning used to justify the previous two rate cuts given that the Board has identified that a tighter labour market is key to inflation sustainably returning to the 2-3% target band. At a speech in the New South Wales' Northern Tablelands last week, RBA Governor Philip Lowe reiterated this message: "there has been an accumulation of evidence over recent times that the economy can sustain lower rates of unemployment and underemployment than previously thought likely". 

Also significant were Governor Lowe's comments on global interest rate settings following the recent broad-based shift to easier policy stances by other central banks: "If we did seek to ignore these shifts, our exchange rate would appreciate, which, in the current environment, would be unhelpful in terms of achieving both the inflation target and full employment" and then went on to say "as a small open economy, we have to take the world and global interest rates as we find them". 

To recap, the key developments since the RBA's previous meeting have been;

• From offshore: Downside risks to the global economic outlook posed by trade and political uncertainty intensified and with inflation pressures remaining soft the US Federal Reserve and the European Central Bank eased their monetary policy stances. In the US, the range for the fed funds rate was lowered to 1.75-2.0% — the second time rates have been cut in the past 3 months. In Europe, the ECB announced a 5-point stimulus package extending on their use of unconventional measures, including; a further lowering of already negative interest rates, restarting quantitative easing, adjustments to forward guidance, a longer and cheaper form of funding made available to the banking sector, and a 'tiering' of the deposit rate effectively charged on banks' excess reserves. 

• Domestically: GDP growth in Q2 came in at 0.5% slowing the annual pace from 1.8% to 1.4% — its weakest since Q3 2009 (see here). The key dynamic was a further contraction in private sector demand, reflecting slowing household spending, weakness in residential construction activity and soft business investment, as robust public demand was kept in train by health-related spending. In contrast to slowing output growth, employment growth remained robust at 2.5% over the year to August — a dynamic helped explained by the ABS's detailed labour force data released last week indicating that almost all of this has been driven by the public sector. Specifically for August, employment increased by a much stronger-than-expected net 34.7k, though that was exceeded by growth in the workforce participation rate to a new record high at 66.2% (see here). As a result, spare capacity in the labour market increased in the month, with the unemployment rate rising from 5.2% to 5.3% — its highest level in a year — while the underemployment and underutilisation rates lifted to 8.6% and 13.8% respectively.    

Given the Board's clear focus on the labour market and the Bank's recent commentary, the rise in spare capacity reported in August's Labour Force Survey seals the case for the cash rate to be cut by 25 basis points to 0.75% today. That view is reinforced by the governor's comments on the implications of the recent easing by other central banks on the exchange rate and, in turn, the RBA's employment and inflation objectives. 

For reference, the cash rate futures market is pricing in a 78% chance of a rate cut at this meeting and the OIS pricing implies a slightly lower chance at around 74%. Meanwhile, 19 of 25 economists surveyed by Bloomberg Australia are forecasting a rate cut today. Note also that later tonight Governor Lowe is scheduled to deliver a speech (7:20PM AEST), which coincidently is the same sequence of events that occurred when the cash rate was cut in June and July. 

Macro (Re)view (27/9) | Markets contend with more uncertainty

In another week highlighted by uncertainty, political developments in the US and the UK led the headlines. In the US, the House of Representatives announced it would commence an impeachment inquiry into President Trump following news he had sought the Ukrainian government to assist with an investigation into one of the Democrats' leading presidential candidates for the 2020 election. Over in the UK, the Supreme Court reached a unanimous ruling that the request by PM Johnson to the Queen (subsequently approved on August 28) to prorogue parliament from early September to mid-October was unlawful.

On the policy front, the recent meeting by the US Federal Reserve highlighted a divergence of views on the Committee regarding interest rate settings and that was evident again this week. Vice Chair of the Federal Reserve Richard Clarida assessed that inflation expectations "were consistent with our price stability mandate", while Chicago Fed President Charles Evans stated that the two previous rate cuts now have the Committee "well-positioned". In addition, Dallas Fed President Robert Kaplan and Richmond Fed President Thomas Barkin, despite noting trade and political headwinds, were non-committal that further cuts were needed. Those pushing the case for an easier policy stance were Minneapolis Fed President Neel Kashkari as he saw "no evidence that the US economy is running at capacity or beyond capacity" and noted dove James Bullard, President of the St Louis Federal Reserve saying; "I think we could do a little more". 

On the US data front, GDP growth was confirmed at an annualised pace of 2.0% in Q2 and was unchanged from the previous estimate. The stated objective of the US Federal Reserve is to maintain its now 10-year long period of economic expansion and the consumer is key to this. Overall, US household consumption is still in robust shape supported by wage gains generated by a tight labour market, though there are reasons to be cautious. Growth in real personal spending on goods and services was softer than expected in August rising by just 0.1%, while the annual pace eased from 4.0% to 3.7%. Consumer sentiment according to the University of Michigan's index lifted off its 3-year low in the previous month to a stronger-than-expected 92.3 in September but is down noticeably over the past year impacted by economic uncertainty domestically and offshore. To date, this uncertainty has impacted mostly on business investment and while data for August was above expectations, durable goods orders have fallen by 3.0% in annual terms compared to a 12.4% pace a year ago, while the less volatile core orders (which exclude investment on transportation assets such as aircraft etc) have slowed to 0.2% from 7.5% in August 2018. Meanwhile, the Federal Reserve's preferred measure of inflation remained below target on a 12-month basis at 1.8% to August, though it lifted from 1.6% in the previous month.   

Across the Atlantic, European Central Bank President Mario Draghi used his appearance before the European Parliament to outline that the 5-point stimulus plan announced by the Governing Council at its meeting two weeks ago was necessary due to "a more rapid and extended slowdown than previously anticipated, persistent and prominent downside risks to the growth outlook, and a further delay in the convergence of inflation towards our aim". Key will be developments around global trade, and by extension manufacturing, given the exposure of the euro area economy to the external sector. For now, the services sector remains resilient highlighted by this week's IHS Markit Flash PMI reading of 52.0 in September, though as President Draghi commented; "The longer the weakness in manufacturing persists, the greater the risks that other sectors of the economy will be affected by the slowdown". These risks are genuine considering that Eurozone manufacturing conditions according to Markit's flash PMI weakened to an 81-month low in September at a reading of 46.0, while in Germany — the bloc's largest economy — conditions are considerably weaker at 41.4, which is a 123-month low. While remaining open to further monetary stimulus, President Draghi reiterated his ongoing call for a more balanced policy mix featuring enhanced support from fiscal policy and structural reform. 

Closer to home, the Reserve Bank of New Zealand elected to leave its benchmark interest rate on hold this week at 1.0%, with the Monetary Policy Committee (MPC) assessing that the economy was around full employment and inflation was within its target range. Following a 50 basis point cut at its previous meeting early last month, the Bank had observed a decline in borrowing rates and a depreciation in the domestic currency. While these factors, together with government spending, are anticipated to support domestic demand conditions over the next 12 months, the MPC does have scope to ease further "if necessary, to support the economy and maintain our inflation and employment objectives".

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Turning to the domestic focus where the feature event of the week was a speech ("An Economic Update") by Reserve Bank of Australia Governor Philip Lowe ahead of next Tuesday's Board meeting. As shown in our chart of the week (below), market pricing indicates a rate cut next week as near to an 80% chance, while 19 of 25 economists surveyed by Bloomberg expect the cash rate to fall to 0.75%. 

Chart of the week

Governor Lowe's speech focused on developments in the global and domestic economies and highlighted caution around the outlook for both. Starting abroad, risks to the growth outlook were described as "increasingly tilted to the downside" due to geopolitical tensions weighing on firms' investment plans, while the dispute between the US and China was clearly driving the slowdown in international trade flows.

From a domestic standpoint, the governor highlighted that the extent of the slowdown in the Australian economy had been sharper than anticipated. To put this in perspective, in February's quarterly statement GDP growth over the year to the June quarter was forecast to be 2.4%, which was then cut to 1.7% in May and then subsequently retained in the Bank's August Statement on Monetary Policy. Ultimately, Q2's GDP growth outcome came in at 1.4% year-on-year (see here). The governor attributed this to slower global economic growth and rising uncertainty, weakness in household consumption growth and the impact of drought conditions weighing on farm output. 

In looking ahead, Governor Lowe outlined that the economy had "reached a gentle turning point" with growth expected to pick up modestly to around trend by next year. That assessment is on based on a combination of factors including; lower interest rates and tax cuts, a weaker Australian dollar, an elevated pipeline of infrastructure projects, a stabilisation of the major housing markets and a more buoyant resources sector. However, as the governor acknowledged; "there are some obvious risks to this outlook", which continue to mainly be around prospects for household consumption growth.

Perhaps a more pressing concern for the Board at next Tuesday's meeting will be the state of the labour market. Once again, the governor highlighted that while employment growth has been robust it has been met with rising workforce participation and thus the labour market has not tightened sufficiently to generate a pace of wages growth that would assist in driving inflation back towards the target range. As such, the assessment was that there has been an "accumulation of evidence over recent times that the economy can sustain lower rates of unemployment and underemployment than previously thought likely". In this context and as covered last week (see here), August's Labour Force Survey contained several weak details; the unemployment rate lifted to its highest in 12 months at 5.3%, while underemployment and underutilisation also increased.  

The other main consideration that points to a rate cut being delivered next Tuesday is the recent easing by other central banks, including the US Federal Reserve and European Central Bank. Governor Lowe outlined that in a global setting of lower interest rates, local resistance to this shift would place upward pressure on the exchange rate, which "would be unhelpful in terms of achieving both the inflation target and full employment". In closing, to achieve these objectives, the governor again reiterated that the Board stands ready to "ease monetary policy further if needed".

Macro (Re)view (20/9) | US FOMC cuts rates; RBA close to easing again

As widely expected, the US Federal Reserve's policy-setting committee (FOMC) cut the fed funds rate by 25 basis points to a range of 1.75-2.0% this week. This was its second rate cut in the past 3 months, and as Committee Chair Jerome Powell outlined in his post-meeting press conference, it was taken to "help keep the US economy strong... and to provide insurance against ongoing risks". These risks relate to weaker global growth and trade tensions. Incidentally, the OECD this week cited the impact of trade tensions as the basis for lowering its outlook for global growth in 2019 to 2.9% — its weakest pace since the GFC.  

As far as the policy outlook is concerned, Chair Powell maintained the guidance that the Committee "will act as appropriate to sustain the (economic) expansion" and avoided repeating the "mid-cycle adjustment" description that had rattled markets when it last cut rates in July. The Committee's updated economic projections indicated that little appears to have changed from its outlook presented 3 months ago. Overall, it remains constructive seeing sustained economic growth, robust labour market conditions and inflation lifting near to its target as the "most likely" outcomes. Of course, the precise policy settings to best ensure this remains the case has been the key issue facing the Committee for some time now, particularly as the risks to its outlook are largely exogenous from its purview. Unsurprisingly, divergence between Committee members' views on this issue was evident again. The vote went 7 to 3 in favour of the 25 basis point cut, and of the 3 dissents, 2 (George and Rosengren) had voted for no cut at all, while the remaining member (Bullard) called for a larger cut of 50 basis points. 

However, it was in the 'dot plot' of participants' individual projections for interest rate settings (including non-voters) where the divergence was most evident. The median projection was for rates to end 2019 at 1.75%-2.0% (i.e. factoring in the rate cut at this meeting), though 7 participants expected that rates would need to be cut again by 25 basis points before the end of the year, while there were 5 participants that had called for no change from the then prevailing level of 2.25%-2.5%. By end 2020, the median projection was for rates to still be at 1.75%-2.0%, which is in contrast to market pricing that is factoring in around 60 basis points of cuts being delivered between now and the end of next year. Markets appear to be confident the FOMC will eventually come into line with their point of view, and they have good reason to be. Consider that back in June, the dot plot pointed to rates ending 2019 unchanged at 2.25%-2.5% only for the Committee to end up cutting twice since then. 

One other point of interest from this meeting was that the Federal Reserve cut the interest rate it pays on banks' excess reserves by 30 basis points to 1.8% (see here). This came in response to a liquidity squeeze in short-term money markets this week, influenced by a combination of factors including company tax payments falling due, and resulted in the overnight lending rate between banks spiking above the fed funds target range. To prevent an inadvertent tightening in financial conditions from taking hold, the Federal Reserve was forced to inject liquidity into the system on several occasions this week, the first time it has had to do so since the GFC.     

In the UK this week, as expected the Bank of England unanimously voted to maintain its existing policy settings. The Bank noted an increased level of caution around trade tensions and, in turn, the global growth outlook. However, Brexit is a more pressing concern and until clarity on the manner of the UK's withdrawal from the EU is gained, it is reluctant to follow the easing actions of other central banks. That said, it recognises that underlying output growth has slowed, due largely to weakness in business investment and exports. The household sector is proving to be more resilient to Brexit and global uncertainties and despite the Bank noting that employment growth was softening, labour market conditions were still assessed as robust. As a result, strength in wages growth is helping to keep the Bank's inflation outlook over the near term anchored just below the 2% target. 

The Bank of Japan also met this week, and while its Policy Board made no changes to existing settings (see here), it highlighted slowing global growth and downside risks to the outlook as concerns and the possibility that "...momentum toward achieving the price stability target will be lost". In such a scenario, the Bank reiterated that it "will not hesitate to take additional easing measures". 

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Locally, the minutes from the Reserve Bank of Australia's policy meeting from earlier this month in which the Board held the cash rate steady at 1.0% were published this week. The key theme remained intact; developments from both offshore, with respect to trade and geopolitical tensions, and domestically, notably around the labour market, are central to the Board's policy outlook right now. 

In terms of offshore developments, the Board is continuing to closely monitor the US-China trade situation, particularly in light of the recent escalation in tensions, which, in turn, have "intensified the downside risks to the global outlook". From the Board's perspective, these tensions have led to a significant weakening in trade volumes over the past year, while geopolitical uncertainty is also cited as a factor weighing on confidence and impacting firms' investment plans across the globe, most notably in the manufacturing sector.

From a domestic viewpoint, while the June quarter National Accounts were released the day after this meeting was held, these minutes showed that Q2's GDP growth outcome of 0.5% led by public demand and net exports amid weakness in private demand (see here) was in line with what the Board had anticipated. Also in focus, conditions in the Sydney and Melbourne housing markets were assessed to be on the improve, though turnover was still low and credit growth was contained despite record low mortgage rates. However, the state of the labour market undoubtedly remains key for the Board. Here, its conclusion was clear with recent data indicating; "...spare capacity remained in the labour market and that the Australian economy could sustain lower rates of unemployment and underemployment".

As such, Thursday's update of the labour market for the month of August was timely. Alas, the Board are, on balance, likely to have been left disappointed with the outcome (see our review here). On the plus side, employment was much stronger than expected for the second straight month rising by a net 34.7k in August against the market forecast for a 15k increase, though the composition was highly lopsided between part time (+50.2k) and full time (-15.5k) work. Rising employment continues to be met by an increasing supply of labour, with the participation rate lifting to 66.2% — the 4th time in the past 5 months it has reached a record high. In fact, on this occasion, participation (+38.8k) increased by more than employment resulting in the national unemployment rate lifting from 5.2% to 5.3% — its highest level in a year. Furthermore, the broader measures of underemployment and underutilisation increased to 8.6% and 13.8% respectively, indicating no progress has been made in lowering spare capacity over the past few months.

Following the employment data, pricing for an RBA rate cut at the next meeting in October moved noticeably higher to imply around a 75% chance of the cash rate falling to 0.75% in two weeks' time. This has the chance to move even higher next week with Governor Philip Lowe due to deliver a speech titled "An Economic Update" on Tuesday night (7:30PM AEST). It is likely Governor Lowe will continue to reiterate that while monetary policy has its role to play in lowering spare capacity, more support from fiscal authorities would be beneficial. 

Fortunately, there appears scope for that assistance to be forthcoming with the Federal Treasurer Frydenberg announcing this week that the underlying cash position in 2018/19 was -$0.7bn (see here). At 0.0% of GDP, the budget position has returned to balance for the first time since before the onset of the GFC and earlier than had been expected, as shown in our chart of the week, below. On Budget night in April, a deficit of $4.2bn (-0.2% of GDP) had been forecast for 2018/19, which was revised up from the initial estimate of -$14.5bn (-0.8% of GDP) in May last year. Key to the improvement has been the boost to national income from elevated commodity prices, while employment growth was also stronger than had been forecast over the past year. Receipts were only marginally higher (+$0.1bn) than anticipated back in April but ended up being $11.5bn above the previous year's forecast. On the other side of the ledger, payments had been revised down by some $4.6bn since April and by $6.6bn over the year, due mainly to underspend in the NDIS and lower GST distributions to the states. 

Chart of the week