Westpac has revised the forecast it released on February 21 that the RBA would cut the cash rate in August and November to June and August.

On February 21 Westpac forecast that the Reserve Bank would cut the cash rate by 50 basis points in two tranches – August and November. Since then markets and forecasters have largely moved in that direction.

We have not changed that forecast since that date.

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However, today, we are announcing an adjustment to the forecast to bring forward the first cut to the June Board meeting with the second cut to follow in August.

We then expect the cash rate to remain on hold through 2020.

This change in forecast reflects the lift in the unemployment rate for April from 5.1% to 5.2% and the confirmation from the Governor that the Board would be closely following developments in the labour market with the primary focus on the unemployment rate.

The Governor’s thinking has evolved over the year to accept that, as we have observed in other countries, upside inflation risks are consistent with a lower unemployment rate than had previously been assessed. For Australia the Bank had believed that the key unemployment rate was 5% – he now accepts that he can drive the economy harder with an associated lower unemployment rate without risking any inflation overshoot.

Recall that the current forecast for the unemployment rate is 5% to end 2020, (falling to 4.75% by June 2021), based on market pricing, which in the May Board Minutes is assessed as “the cash rate was expected to be lowered by 25 basis points within the next three months and again by the end of 2019”.

In his speech “the Economic Outlook and Monetary Policy”, released today, he gives the strong guidance that “at our meeting in two weeks’ time, we will consider the case for lower rates”.

Recall that other aspects of the Bank’s current forecasts are underwhelming despite the assumption around lower rates – 2.6% growth in 2019; 1.75% trimmed mean inflation in 2019; and 5% unemployment rate by end 2019.

With the June rate cut virtually locked in the issue is why we expect a follow up move in August.

Firstly, that timing is a little more aggressive than was used in the May SOMP and therefore could reasonably be associated with somewhat more optimistic forecasts.

Secondly, we expect that the June quarter trimmed mean inflation print (released on July 31) will be 0.4% indicating that underlying inflation will print 0.7% for the first half of 2019, making it difficult to persist with a 1.75% forecast for underlying inflation in 2019 – downgrading the underlying inflation forecast to 1.5% in 2019 will make it difficult for the RBA to credibly forecast a return to 2% inflation in 2020. The Bank may choose to persist with overly optimistic forecasts but will need to ease again to emphasise its inflation targeting credentials.

This second cut would also be consistent with the assumptions that have underpinned the May forecasts .

Key to Westpac’s rate cut forecast on February 21 was the expectation that the unemployment rate was likely to reach 5.4% by end 2019. Our work around the weakness in the cyclical parts of the labour market ( around 60% of employment) which is already apparent and recent trends in the business surveys signal that the softening in the labour market can be expected to become more apparent in the next few months.

We also expect that the March quarter GDP report (released June 5) will confirm the Bank’s recent downbeat assessment of the consumer ( consumer spending growth in 2019 revised down from 2.5% in February to 2.0% in May) and note that the May Minutes see downside risks to the consumption forecasts.

Note also that the May Minutes point to downside risks for the global economy and confirmed in today’s speech.

Looking further out it is important that the Governor stressed the importance of the exchange rate in the monetary policy transmission mechanism. Accordingly, in order to extract ongoing “dividend” from the rate cut cycle it seems likely that the August RBA decision will not preclude further action.

However, our current assessment is that with the housing market stabilising in 2020 and the RBA uncertain about the impact of sub 1% cash rate on the economy the eventual low point in the cycle will prove to be 1%. This view is consistent with our original call back in February this year.

Our forecast low point of USD0.68 for the AUD which printed in our report on February 21 was predicated on the two cuts – the change in the timing of the cuts does not materially affect that call.

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