Key insights from the week that was.
Following two speeches from the RBA this week, Westpac Economics changed our RBA view. A further cash rate cut to 0.25% in June is now expected following a (long-foreseen) February cut to 0.50%. We now expect QE will not begin in Australia until the second half of 2020.
As detailed by Chief Economist Bill Evans, Governor Lowe was clear in his speech that the RBA see 0.25% as the effective lower bound for Australia’s cash rate. This is because the interest rate paid on reserves at the RBA is 25bp under the prevailing cash rate and therefore [a cash rate at 0.25%] would mean the “Reserve Bank would already be at zero”. For the RBA, it is only after this level is reached that “QE will become an option”.
From the above, it is clear that the hurdle for QE to be introduced in Australia is high. However, to our mind, an unemployment rate forecast to be stuck at 5.6% from mid-2020 (well above the 4-4.5% full-employment level) and the Australian dollar remaining at risk of appreciating as the US FOMC delivers three cuts through the year will require the RBA to provide further policy support via QE. We see monthly government bond purchases in the order of $2-3bn for an open-ended period from the second half of 2020.
Note that the June cut and the adoption of QE does not remove the need for fiscal policy to be eased. Recently we have been emphasising that the 2022/23 personal tax cuts could be brought forward to 2020/21 and 2021/22 without the budget falling back into deficit.
In addition to persistent global risks, the case for complementary monetary and fiscal support in scale is made by two pressing domestic realities. First is the enduring weakness in wages growth, which has and will continue to materially restrict consumer spending. Second is the expectation that business investment will struggle to gain traction over the outturn.
Deputy Governor Debelle made clear in his speech this week that soft wages growth is becoming more entrenched in Australia. The distribution of wage gains has narrowed around a historically-weak 2-3% range. Further, this soft momentum is increasingly being locked in for longer periods as enterprise bargaining agreements are lengthened.
There is currently no need for employers to bid up wages to attract new staff, with the supply of labour plentiful thanks to rising participation amongst prime-aged women and as older workers remain in the workplace for longer. Deputy Governor Debelle’s speech highlighted that, for both groups, financial considerations (the cost of living and household debt) are key, while individuals’ willingness to participate is also being aided by labour market flexibility. If the Australian economy is to achieve trend growth, employment opportunities for all entrants must remain strong, to reduce labour market slack and buoy wage gains. If not, consumption growth will remain sub-par and at risk over the forecast period, as it has the past five years.
The other major concern for Australia’s domestic economy is soft business investment. Both construction work and equipment investment contracted in the September quarter, signalling some downside risk to our 0.6% estimate for Q3 GDP (due next week). The bigger concern though is that expectations of business investment look to have deteriorated.
Whereas the prior CAPEX survey expectation for 2019/20 investment pointed to a near 11% nominal gain, the most recent estimate suggests a rise of only 2.5%. Moreover, the mix of investment by industry is troubling, with the gain coming as a result of a resurgent mining sector after six years of decline. In contrast, a decline in service sector investment is projected. Needless to say, achieving trend growth in 2020 or beyond in these circumstances seems highly unlikely absent considerable policy support.
Turning to offshore matters, it was a quiet week as the US celebrated Thanksgiving. The major development of note was that President Trump signed the Hong Kong Human Rights and Democracy act into law. How this affects ongoing US-China trade negotiations in coming weeks will be of keen interest. Note, a new tranche of US tariffs is also still scheduled to be implemented on December 15, if a phase 1 deal cannot be reached before then.
Across to Europe, a new European Commission led by Germany’s Ursula von der Leyen was approved and will take office on December 1. In the UK, the clock continues to tick down to the UK general election on December 12. Bookies odds now give a Conservative Majority around a 70% chance after an influential YouGov poll predicted a 68 seat advantage.
