Key insights from the week that was.
Policy makers have controlled the headlines this week here and offshore.
Beginning with the RBA, the minutes to the June meeting highlighted that the RBA believe the outlook for the Australian and global economies remains “reasonable”. The justification to cut in June and the belief that “a further easing in monetary policy would be appropriate in the period ahead” instead rests on spare capacity in the labour market, which the RBA believes can be materially reduced without any risk to inflation. Highlighting the scale of the challenge before the RBA, the unemployment rate is currently 0.7ppts above the RBA’s revised estimate of the full employment level (4.5), while underemployment is 1.1ppts above the level seen post-GFC.
Reaffirming that more easing is necessary to remedy the situation, in his subsequent speech on the labour market, RBA Governor Lowe stated it would “be unrealistic to expect that lowering interest rates by ¼ of a percentage point will materially shift the path we look to be on” and that the “most recent data – including the GDP and labour market data – do not suggest we are making any inroads into the economy’s spare capacity”. That said, there was no real urgency in the language used for the policy outlook, with “the possibility of lower interest rates” simply still “on the table” as the RBA seeks to achieve its “medium-term” objectives. Notably, there was also a further call for fiscal policy and structural reform to be used to support the economy in its time of need.
The market certainly believes that the case for immediate action has been made, having now priced a 75% chance of a follow-up cut in July. But waiting until August would allow the RBA to craft their narrative better, being the month when their revised forecasts and in-depth analysis on the economy will next be delivered in the August Statement on Monetary policy. We remain of the view that cash rate cuts in August and November to 0.75% is the most appropriate course for the RBA.
Of the Antipodean data, New Zealand Q1 GDP was most certainly the highlight. As expected by our New Zealand economic team, growth came in at 0.6% – in line with the market, but above the RBNZ’s +0.4% expectation. Positive revisions were also seen, leaving annual growth at 2.5%yr. This result should be enough to see the RBNZ remain on the sidelines, particularly as growth is expected to pick-up.
Turning to the US, the FOMC made a significant change to their policy stance in June. While remaining constructive on the US economy, their focus clearly shifted to the risks emanating from trade tensions and global growth. Seven of the seventeen Committee members now see two cuts in 2019 – another member, one cut.
Two cuts is Westpac’s expectation. We see this response as sufficient to ward off the negative effects of US trade tensions as they currently stand. Of course the chance of a further escalation is not immaterial. If that were to occur, then the market’s view of 100bps of cuts over the coming year could instead prove warranted. Crucial will be whether current “uncertainties” only impact investment or also employment and consumption.
While the Fed certainly took centre stage, this week we also received updates from the ECB, BOJ and BOE.
ECB President Draghi delivered a surprise at the Bank’s annual Sintra conference, strengthening their conditional easing bias only two weeks after introducing it at the June meeting. Previously the ECB were “ready to act” if “adverse contingences” materialise. Now the ECB holds that in “the absence of improvement, such that the sustained return of inflation to our aim is threatened, additional stimulus will be required.”
This change in tack drew the ire of President Trump who accused “Mario D” of unfairly depreciating the Euro. As would be expected, Draghi reiterated that the ECB target inflation, not FX. We would add however, that the former is in part dependent on the latter, and we sense a degree of competitive policy making as global banks, in unison, turn dovish.
On that note, the BOJ kept policy steady at Thursday’s meeting and noted increased downside risks. They also mentioned the possibility of lowering short term rates, increasing asset purchases, as well adjusting their 10 year target and trading band. As with the ECB, the challenge for the BOJ is establishing credibility that they have capacity to ease policy even further.
Of the Banks meeting this week, one major is still reluctant to join the flock however. In June, the BOE held the bank rate at 0.75% and reiterated their mild tightening bias. A key reason for their intransigence is that, unlike in Europe and the US, headline inflation is at target while wages growth remains above 3%. Of course, the BOE emphasised that policy guidance is highly provisional on a smooth outcome to Brexit. In that regard, the race to be the new UK Prime Minister has narrowed to two, Boris Johnson and Jeremy Hunt – the former being the firm favourite.
