The first RBA meeting of 2019 takes place on Tuesday and will be followed by a speech from Governor Lowe on Wednesday and Statement on Monetary Policy on Friday. We believe the RBA will lower their growth forecast in response to recent data but maintain an outlook consistent with rates remaining on hold.
After the usual summer recess the Reserve Bank will conduct its Board meeting on February 5, followed by a speech from Governor Lowe on February 6 and the February Statement on Monetary Policy which will print on February 8.
Of course there will be no rate change following the Board meeting but there will be considerable interest in the Governor’s Statement and the subsequent communications.
Recall that the minutes of board meetings have usually contained words along the lines of “members continued to agree that the next move in the cash rate was more likely to be an increase rather than a decrease.” Alternatively the November Statement on Monetary Policy noted “further reducing unemployment and ensuring inflation is consistent with the target. If that progress is made higher interest rates are likely to be appropriate at some point.”
But those sentiments were expressed when markets had been anticipating rate hikes. At the beginning of 2018 when Westpac was predicting the cash rate would remain on hold in both 2018 and 2019, markets had priced-in a full 25bps rate hike by end 2018. Today, markets are assessing that the next move in the cash rate will be down by 25 basis points with a probability of 60% (15bps) by year’s end.
In defence of the economists, only 11 of the 20 forecasters (Bloomberg Survey, January 12, 2018) predicted a hike or hikes in 2018 but this group did include the other three major banks, AMP, and most major investment banks. There is no survey evidence to check how many of the “no-change nine” supported the Westpac view that rates would remain on hold through 2019 as well. Since that survey in January last year Westpac has extended its “on hold view” through 2020. Turning to today, there is also, at this stage, little support from the economists for the “market view” which is pricing rates to be cut by end 2019.
The key as to whether the Reserve Bank will placate markets and adopt a pure neutral bias by eliminating the “next move up” in its commentary will hinge on how it reassesses its forecasts which will be released with the February Statement on Monetary Policy (SOMP) on February 8.
Recall that, based on its forecasts in the November SOMP, the conclusion that the cash rate would eventually rise was reasonable.
Growth was forecast at 3.5% in 2018; 3.25% in 2019; and 3% in 2020. Trend growth is assessed by the RBA as 2.75% (1 ppt for productivity growth and 1.75 ppts for labour force growth).
Three consecutive years of comfortably above trend growth could be expected to erode significant excess capacity and boost employment growth so that inflation would lift into the 2-3% target range and the unemployment rate would approach the NAIRU. Accordingly, the Bank forecast core inflation to lift to 2.25% in 2019 and 2020 and the unemployment rate to fall to 4.75% by end 2020.
The December quarter inflation report printed underlying inflation at 0.4% and headline inflation at 0.5%. These numbers were around market expectations although there was a “whisper” number in markets of somewhat lower. Importantly, the print for underlying inflation for 2018 was 1.7% – in line with the Reserve Bank’s forecast from its November SOMP.
The November inflation forecasts for 2019 and 2020 are 2.25% – a marked lift from the 2018 actual of 1.7% but it is likely the Bank will persist with this confident signal in its February forecasts. Even if it decides to lower the 2019 forecast to 2.0% in recognition of a lower growth forecast for 2019 the number would still be in the target zone (2–3%) and the gradual progress would be emphasised by maintaining the forecast for 2020 at 2.25%.
Their views on the labour market have been cautious. The unemployment rate has already reached 5% while the Wage Price Index growth rate has lifted in recent quarters to 2.3%. Scrutiny of a chart which, for the first time, was provided in the November SOMP points to a cautious forecast of WPI annual growth reaching 2½ per cent by end 2020.
However, the September quarter GDP report has disrupted the RBA’s comfortable position on the growth outlook. With growth only printing 0.3% in that quarter it would be necessary for the December quarter to print 1.2% to achieve the November forecast of 3.5%. The 2018 growth forecast is likely to be lowered from 3.5% to 3.0%. But what will this mean for the 2019 and 2020 forecasts?
We know that the Bank has assessed a minimal wealth effect on consumption and the Q3 growth report is unlikely to have changed that view. Even further negative evidence on house prices in Sydney and Melbourne is unlikely to change the qualitative assessment that the wealth effect was minimal while house prices were booming and therefore will be minimal in reverse. RBA Director Harper recently played down any evidence of a wealth effect in an interview with Dow Jones late last week.
Westpac differs in that regard pointing to a fall in the savings rates in NSW and Victoria over the year to September 2018 of 1.7 ppt’s in NSW and 1.9 ppt’s in Victoria. We expect some reversal of that effect in 2019 and 2020 pushing growth in consumer spending down from our previous forecast of 2.6% in each year to 2.4%. Our simulation work suggests that the impact on consumption of this negative wealth effect may be significantly larger. We expect the Bank will maintain its current view that consumption growth will run at 3% in both 2019 and 2020.
We also differ on the likely downtrend in residential construction in 2019 and 2020, “Dwelling investment has remained high and… should remain at a high level for the next year or so” (Nov SOMP). Based on the recent falls across the board in dwelling approvals (detached and multi) we look for a 8% fall in new dwelling construction in 2019 and 5% decline in 2020.
Westpac’s growth forecasts are 2.6% in 2019 and 2.6% in 2020. Those forecasts are only slightly below trend and consistent with steady rates in 2019 and 2020.
We expect the RBA will forecast growth of 3% in 2019 and 3% in 2020. That higher growth will reflect a limited slowdown in housing construction and no meaningful wealth effect. Those growth forecasts are still above trend and likely to ensure the view that the next move in rates will be up.
Indeed, in his comments to Dow Jones, Director Harper repeated the expectation that the next move in rates will be up. While he emphasised these were his own views it is important to point out that Dr Harper has a distinguished past in the Research Department of the Bank. Some of the Bank’s senior executives would have been colleagues. His comments carry much more weight than the personal observations of an outside director.
Of course we need to be mindful that the comments preceded the shock from the monthly NAB Business Survey that showed a collapse in business conditions (business confidence held around previous levels). Risks around business surveys that are taken in January must be recognised. Indeed that particular survey has shown some volatile movements around the Christmas period. It is doubtful that the Bank would change its longstanding rhetoric on the basis of a January Business Survey.
If, however, we thought the RBA was likely to lower its growth forecasts in 2019 and 2020 to 2.5% or less then we would certainly expect it to adopt an easing bias.
Other factors which may impact market thinking are the higher recent levels of BBSW and associated out of cycle hikes by some banks. The RBA will probably view those developments as likely to exacerbate housing price weakness but due to an insignificant wealth effect, will be unlikely to materially change their forecasts.
Accordingly, despite lowering its growth forecasts for 2018 and 2019, we expect the Bank will retain its current stance that the next move in rates will be up.