As expected the RBA Board lowered the cash rate by 25 basis points at its October meeting to 0.75%.
Back in July we identified October and February as the likely dates for the next moves. At that time only 3 forecasters out of 24 in the surveys were forecasting an October move and most were not anticipating a terminal rate as low as 0.5%.
We have not changed our forecasts since then and therefore welcome the Governor’s Statement which opens the door for another move.
However we cannot concur with the markets pricing in around a 50% probability of a follow up move in November.
There are a number of reasons for this caution.
Firstly, markets should understand that central banks will usually bias their comments on days on which they make policy changes to justify the decision. We saw some examples of that approach in the Governor’s Statement.
For example, he has, for no reason that is justified by the data, adopted a bolder objective than had been the case before by aiming for “full employment” rather than the more modest, “reduce unemployment” that we saw in September.
With the unemployment rate trending away from his full employment target and, by his own admission, “forwardlooking indicators of labour demand indicate that employment growth is likely to slow from its recent fast rate” the introduction of that full employment target as a substitute for the more realistic “reduce unemployment” seems curious and is probably less significant than markets may have assessed.
In full, he noted, “the Board will continue to ease monetary policy further if needed to support sustainable growth in the economy, full employment and the achievement of the inflation target over time.”
A more significant aspect of that statement is the choice of the term, “if needed” which arguably implies that time will be taken to assess the impact of the three cuts in this cycle before moving again (note that he did not use “if needed” following the June decision which was subsequently followed up by a cut in July.)
We also think the RBA will be mindful of the response of the Westpac Melbourne Institute Consumer Sentiment Index to the consecutive cuts in June/ July. Following the cut in July the Index fell by 4.1%. There was an apparent “spooking” of the consumer around the policy action.
At the time we noted: “The main driver continues to be deepening concerns about the outlook for the Australian economy and prospects for family finances. The index components show the biggest decline in the sub-index tracking expectations for the ‘economy, next 12 months’ which slumped 12.3% to be down 16.4% since May to its lowest level in four years. Longer term expectations for the economy were also pared back sharply, the ‘economy, next 5 years’ sub-index falling 6.7%.”
With the RBA seeing the consumer as the key to the growth outlook, a “back to back” series of rate cuts leaving limited scope to cut further and risking a similar response from the consumer would counsel against that November move.
Finally, let me cast a bit of doubt about the prescience of market pricing.
Our Strategists, calculated that, prior to last Tuesday, there were seven occasions in recent years when market pricing was in the 70-80% probability range on the day before a rate decision. On three of those occasions the RBA did not move as expected by the market.
The first two such “surprises” were in February 2010 and February 2012. On both occasions the RBA had moved rates consecutively on the previous three (2010) and two (2012) meetings. The markets responded to the RBA’s strong case for moving (to justify the move) and assumed the sequence would continue. Assuming continuation of a sequence is always dangerous for markets and we expect such danger “lurks” for November as well.
A second doubt about the reliability of market pricing is the obvious – pricing can change drastically.
Recall that market probabilities for the October move were as low as 20% in the week preceding the release of the September Board minutes.
While these arguments, I believe, cast considerable doubt over the market’s outlook for a November move, they have much less impact on the probability of a move in December.
Markets’ probability for December of 80% is substantially boosted by the 50% for November. That pricing still looks too high but certainly makes more sense than the November pricing.
Recall that one reason why we held our “October” view for some time was because October gave the RBA the option to move again in December without risking the confidence impact of back to back moves.
That option now exists. We still favour a longer wait, to February, but can certainly envisage circumstances around global rates and the employment reports that would promote the December option.
