This week’s speech was more guarded than we saw in May but easing cycle has now begun and key theme around unemployment was very similar while global views have changed.
The Reserve Bank Board meets next week on October 1.
We expect the Board will decide to cut the cash rate by 0.25% from 1% to 0.75%.
A cut at the October meeting has been our call since July 24. In fact, in the Bloomberg survey of 24 forecasters on August 2 only 3 forecasters (including Westpac) forecast a move in October.
Last week we covered our assessment of the key developments during that week – the September Board minutes; the FED’s decision to cut the federal funds rate by 0.25% and the August Employment Report.
We concluded that those developments were in line with our expectation of a cut in October.
This week we have seen a new speech from the Reserve Bank Governor, “An Economic Update.” which was delivered in Armidale (a regional city) on September 24, only seven days before the Board meeting and on the eve of the one week blackout period.
Markets were anticipating similar conclusions to those which were contained in the speech “The Economic Outlook and Monetary Policy” which was delivered on May 21, only 14 days before the June 4 Board meeting.
In that speech the Governor concluded, “A lower cash rate would support employment growth and bring forward the time when inflation is consistent with the target. Given this assessment, at our meeting in two weeks’ time, we will consider the case for lower interest rates.”
That was a very strong statement almost promising the rate cut that was subsequently delivered on June 4 and signalled the beginning of an easing cycle that marked the first move since August 2016.
But we must appreciate the circumstances of that speech. Following the release on April 24 of the sharply low inflation print for the March quarter (underlying inflation measures averaged 0.2% for the quarter and 1.5% for the year) many commentators demanded that if the Bank was to be credible with its inflation targeting mandate it should cut the cash rate at the next Board meeting.
Westpac was not one of the “commentators” calling for a rate cut at that May meeting.
We thought there a number of good reasons for not moving in May. In particular, the Board did not have an easing bias following its April meeting and moving to cut rates from a neutral bias would be highly unusual.
However, given the widespread criticism the RBA received from some quarters for not moving in May it is not entirely surprising that the Governor was keen to signal an imminent move when he delivered his speech on May 21. That was supplemented by a clear easing bias in his Statement following the May Board meeting.
There was no such need or “pressure” to make such a specific statement in this week’s speech given that the easing cycle had begun and the easing bias was consistently noted in the statements following the June to September Board meetings.
In the speech he did note that “further monetary policy easing may well be required” and concluded “At our Board meeting next week, we will again take stock of the evidence … The Board is prepared to ease monetary policy further if needed …”.
That conclusion was in line with the standard conclusion from the minutes and would have disappointed those folks who were expecting something akin to the conclusion on May 21.
But there was a common thread in the two speeches that have sustained our expectations for a move next week. Consider the key observation in the September speech, “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 May he noted, “My judgement of accumulating evidence is that the Australian economy can support an unemployment rate of below 5% without raising inflation concerns”.
My assessment is that this theme that laid the foundations for the move in June and now figures just as prominently in the September speech is one of two key supporting signals for a move next week.
Note that since that speech in May the reported unemployment rate has drifted up from 5.2% to 5.3% and the underemployment rate has lifted from 8.5% to 8.6%.That further deterioration in the underemployment rate would have been particularly disappointing given that it had lifted sharply from 8.2% to 8.5% between March and April.
So while this theme around the need to lower the unemployment rate was common to both speeches the speech in September gave much greater emphasis to global issues and, particularly, global interest rates and currencies.
In May he noted that “Looking forward, the global picture looks a little brighter and it is reasonable to expect that growth will strengthen a little later in the year”.
In September he notes, “the increased downside risks generated by various geopolitical developments”.
Finally in May there was limited discussion about global interest rates and the need to keep the AUD competitive.
In September, he introduced a second key theme. He notes, “We live in an interconnected world … we can’t ignore structural shifts in global interest rates… if we did … our exchange rate would appreciate which… would be unhelpful in terms of achieving both the inflation target and full employment”.
Of course since that speech in May the US Federal Reserve has begun an easing cycle with cuts to the federal funds rate at its last two meetings in July and September. Markets are currently pricing in another three cuts through 2020. Westpac is forecasting four more cuts through the remainder of 2019 and 2020.
In conclusion, markets were disappointed that the Governor did not give direct guidance in his speech this week along the lines of the speech in May. We assess that having now begun the easing cycle it is appropriate to return to a more opaque approach to future policy movements. However the key domestic theme was similarly emphasised in both speeches while this week’s speech bolstered the case for a cut by highlighting the global developments that are signally the need for lower rates.
