As expected, there are no real surprises in the June minutes; the Board sees the possibility of a “shallower than expected downturn” but the outlook remains “highly uncertain”.
The Reserve Bank Board minutes for June have produced no surprises.
Policy is firmly on hold with the distinction on the timing of the maintenance of the 0.25% three year bond target being related to “progress on the inflation target” and the cash rate target being “inflation will be sustainably within the 2–3 % target band”. The full employment target only requires “progress” in both cases.
Westpac continues to forecast the lifting of the three year rate target to around 0.4% by mid-2022 while the cash rate target will remain in place beyond the end of 2023.
The Bank’s current forecasts ( May Statement on Monetary Policy) are for the unemployment rate to be 6.5% and the inflation rate 1.5% by June 2022 (end of Bank’s current forecast horizon), broadly in line with Westpac’s central view.
However, recall that in the May Statement on Monetary Policy the Bank talked about an “upside” scenario where the unemployment rate would reach 5% by mid-2022. Such a development (which is not Westpac’s forecast) would see markets challenging the three year bond rate target through the second half of 2021 and the cash rate target in the first half of 2022.
There are some interesting observations in the minutes which are not market moving but worth noting.
On The Economy:
- “It was possible that the downturn would be shallower than earlier expected…. However the outlook remained highly uncertain and the pandemic was likely to have long-lasting effects on the economy”.
- “There continued to be material downside risks to the global outlook”. These risks revolved around infection rates unexpectedly rising or lack of policy support (or virus concerns) constraining spending.
- Domestic liaison reports suggested that household spending had recovered somewhat in May. Further, the total decline in hours worked may be less than previously feared.
- Domestic liaison indicated that “the pipeline for work was diminishing as firms deferred or cancelled investment in projects”.
- Domestic liaison program indicated that “buyer interest in new dwellings had declined significantly over recent months as uncertainty about incomes and the availability of finance had escalated”.
On Markets and Policy
- In the section on International Financial Markets :”Market participants had not ruled out the prospect of additional monetary support in the period ahead, including the possibility of negative policy rates in a number of jurisdictions”. However negative rates had been ruled out by the Federal Reserve as “likely to be counterproductive”.( no discussion of negative rates in the Domestic Financial Markets section).
- Yields on AUD bonds in the one to two year maturities had risen above the three year target rate due to liquidity and technical reasons. “The Bank would consider purchasing bonds in the secondary market to ensure that these short term yields are consistent with the target for three year yields” It is my view that the Bank will remain firmly focussed on the short end of the yield curve given the relative importance of short rates for private sector rates such as fixed rates for mortgages and business loans. As borrowers become convinced that the Bank will respect the effective lower bound for the cash rate as, for now, is certainly the case, the attraction of fixing borrowing costs will increase.
- ”Movements of the Australian dollar over the course of this year had been closely correlated with global equity prices”. Commodity prices and interest rate differentials “had generally been little changed since earlier in the year”. AUD had appreciated “to be around levels previously recorded in January”. That commentary indicates that the Bank is comfortable to signal that in terms of key fundamentals the AUD has really only moved back into line with its January level.
Of course the “complication” arises with the May forecasts which we discussed above. Those forecasts were based on an AUD of USD0.64 over the forecast period.
Late last week Westpac raised its forecast for AUD to USD0.72 by end 2020 and USD0.76 by end 2021. That would imply an average AUD around USD10c higher than the RBA’s current forecast base.
The RBA will find challenges with AUD over the forecast period although the much more compelling risks to the forecasts will remain unexpected domestic and global developments with the virus.
I have recently discussed the substantial likely benefit to the RBA’s objectives from a lower AUD which would surely result from further cuts in the overnight cash rate including moving into negative territory. Although the minutes’ only reference to negative rates is the US assessment as “counter- productive” this may change if developments both domestic and global disappoint.
