The Reserve Bank has nominated downside risks to their outlook for the consumer in the December Board minutes. With the Board meeting pre-dating the September GDP report the growth outlook will need to be revised down. In February we are likely to see a Bank which is more aligned with trend growth than the current forecasts of comfortably above trend.
The minutes of the December monetary policy meeting of the Reserve Bank Board reveal a Board which is less confident about the economy than has been the case in the past.
Of most interest is a more detailed explanation of the prospects for the consumer. In the past, the outlook for the consumer was described as a source of uncertainty. In today’s minutes, the issues around slow income growth, high debt levels and falling house prices are explained as being a combination of factors which are posing downside risks to the outlook for the consumer. This issue is critical to the Bank’s central view because trend growth in consumption is likely to be necessary to sustain strength in the labour market and a gradual pick-up in wages growth. In turn, that combination is expected to lead to further falls in the unemployment rate.
Accordingly, the minutes affirm “members continue to agree that the next move in the cash rate is more likely to be an increase than a decrease”.
However, this statement was made when, according to the minutes, the Bank expected GDP growth in the year to the September quarter to be above 3 per cent. The GDP report, which printed the day after the Board meeting, showed growth of 2.8% – around trend. Growth relative to trend is an important parameter for the Bank. Note in the minutes how falls in the unemployment rate “were likely given the expectation that the economy would continue to grow above trend”.
In our view, the Bank is now likely to revise down its forecast growth in 2018 from 3.5% to 3.0% (just above trend of 2.75%) in the February 2019 Statement on Monetary Policy.
The 2019 forecast should be lower than 2018 given the uncertainty around the housing market and the consumer. The Bank may choose not to reduce 2019 to 2.75% (despite current forecasts having 2019 0.25ppts below 2018) because the Bank seems to be in denial that dwelling investment will contract in 2019 and 2020 – “dwelling investment was expected to remain around this level for at least the following year or so”. A somewhat conflicting indicator of that view can be found in the minutes where “liaison with developers indicated that demand for new detached housing in eastern Australia had eased… and some developers had reported that this decline in demand had become more pronounced. Demand for off-the-plan apartments had declined significantly since mid-2017”.
With a typical lag on detached housing between approval and commencement being about three months, it seems unlikely that the Bank’s forecast on dwelling construction will be justified.
There is considerably more discussion around the state of the housing market with house prices in Sydney now having fallen by 9 per cent since July 2017 and 6 per cent in Melbourne since November 2017. Also note that house prices in Perth and Darwin “had returned to levels seen a decade earlier”. This final observation certainly puts into perspective the assertion from some that housing downturns are short-lived.
As with previous minutes, credit conditions are described as “tighter than they had been for some time” with particular focus on the Royal Commission reducing some lender’s appetite. It is also interesting that this tightening is described as targeted at not only housing but also small business.
On the positive side, investment expectations had lifted; employment growth is holding at 2.5%; and there has been a small pick-up in wage price index growth over the previous two quarters.
Sentiment around the global economy is a little more guarded than we have seen in previous minutes – “there had been some loss of momentum in external demand in all regions”, partly related to trade tensions. China’s efforts to deal with risks in their financial sector remain a consistent theme in the minutes with the contraction in non-bank lending risking credit availability to smaller enterprises. The Board discussed credit conditions in the US noting a modest tightening and high non-financial corporate leverage. With recent developments in the US equity market, no doubt there will be greater attention being given to US financial markets to complement the coverage on China.
Conclusion
The sentiment in these minutes is somewhat less confident about the Australian economy than we have seen in previous minutes, although the outlook for higher rates is once again confirmed. Certainly, at this stage, the Bank cannot be described as having moved to a ‘neutral’ bias. However, taking into account the attention given to the credit; housing; consumer; and external risks, these minutes should be interpreted more ‘dovishly’ than we have seen over the course of 2018.
Readers will be aware that Westpac has consistently called the cash rate on hold since the August 2016 rate cut in its standard 2-3 year forecast horizon. Markets are now closely priced to our current view that rates will be on hold in 2019 and 2020.
However, traders will want to price-in some scenario for “rates activity” . These minutes are more likely to encourage them to price-in lower rates than the alternative.
