Key insights from the week that was.
With respect to the RBA, last week’s downside surprise for inflation has firmed up rate cut expectations amongst market participants. Two cuts in the cash rate in 2019 has been Westpac’s expectation since February. This view has now become the market consensus, albeit with a difference of opinion still evident on the months the cuts will be delivered.
Market pricing currently points to a May cut being a 45% chance after it peaked at roughly two thirds immediately after the disappointing March CPI outcome. 2016’s rate cuts have been used as justification for immediate action in 2019 given both episodes saw inflation well below target. However, as detailed by Chief Economist Bill Evans this week, we believe 2019 is different for a number of reasons, including the fact that the RBA carried an explicit easing bias into the 2016 May meeting, which is not the case in 2019.
With the trimmed mean March quarter print of 1.6%yr as a starting point, we believe the RBA will continue to forecast a return to the bottom half of the 2-3%yr target range over 2020 and 2021, supported by confidence in the labour market. It also seems most likely that the RBA will forecast at-trend GDP growth in 2019 and near-trend in 2020 in May, only moving to a clear below-trend view for both years in August. This would be consistent with the adoption of an explicit easing bias in May followed by a cut in August. If we are right, then the anticipated follow-up cut will come in November. Note that the RBNZ also meets next week. Our NZ economics team sees a RBNZ cut in May as a 55% chance.
Albeit not as significant for the RBA as inflation, both the March private credit data and April update of CoreLogic dwelling prices pointed to a moderation in the pace of deterioration for the housing sector.
Offshore, the FOMC was the focus this week. The market’s initial reaction to the statement was dovish, owing to explicit recognition by the Committee that core inflation had fallen below their 2.0%yr medium-term target. However, this market reaction subsequently reversed course as Chair Powell made clear in the press conference that core inflation was expected to return to target. Chair Powell and the Committee were also more positive on the outlook for consumption and investment, and viewed downside risks from the global economy as having receded. We foresee little risk of the FOMC doing anything other than remaining on hold over our forecast horizon – 2019 and 2020.
Over in the UK, the Bank of England also held policy steady in May. In their May forecasts, the BoE Committee was more positive on the underlying economy and, despite delays, continued to assume a smooth transition through the Brexit process. However, lower global rates saw the Committee revise down their path for the Bank Rate to a peak of 1.00% – just 25bps above the current level. To our mind: the risks around Brexit are greater than the BoE assumes; and continued delays in the process are damaging to the UK’s long-term growth prospects in their own right. We look for the BoE to remain on hold through 2019 and 2020.
Turning to Europe, growth picked up in the first quarter of 2019, with the first estimate of GDP recording a 0.4% increase. Detail is scarce at this stage, but national estimates indicate Spain rose 0.7%; France gained 0.3%; and Italy emerged from recession, up 0.2%. While annual Euro Area economic growth is tracking at 1.2% – just below long-run potential – the labour market is strengthening. The unemployment rate has maintained its trend lower, coming in at 7.7% in March – not far from the pre-GFC low of 7.2% and down from 8.5% a year ago.
The recent run of data would surely have elicited a sigh of relief from the ECB and stakeholders in the European economy, but uncertainty still shrouds the economic outlook. The European manufacturing sector remains weak on the back of a turn in the global tech cycle, and while some political risk has eased (the Brexit extension, Italy avoiding an S&P downgrade for now, and a benign Spanish election outcome), the 23–26 May European Parliament Election will be closely watched.
Finally in China, the official manufacturing PMI disappointed in April, albeit while holding above the 50 expansion/ contraction level. Versus the average of the past two years, the services outcome was more robust, being only marginally below average in April compared to the manufacturing survey which is more than a point down. While significant in scale and well planned, the 2018/19 stimulus will only slowly improve underlying momentum in China. This is in part due to headwinds from offshore, but also because the quality of growth remains in sharp focus. This is most evident in the slow improvement in the investment detail and the credit data – where accelerating growth is coming from bank lending and market issuance, not shadow lenders.
