Key insights from the week that was.
This week has brought a double policy benefit to Australia in the form of a cut in the cash rate from the RBA and the passage of the Federal Government’s tax plan. Data has however highlighted that such support remains a necessity.
In justifying their decision to cut for a second time in as many months to a new historic low of 1.00%, the RBA again focused on Australia’s labour market and the need for it to strengthen. Unemployment and underemployment both remain well above the levels the RBA see as consistent with full employment. Hence, if wages growth is to accelerate, GDP growth must rise back to trend or above and labour market slack be reduced.
While the RBA looks set to hold onto their expectation of trend growth in 2020 for now, by November we believe they will have to revise this forecast down and, in doing so, will justify another cut. As highlighted by Chief Economist Bill Evans, the risk to this view is that two rather than one cut is necessary by year end, and subsequently that the RBA may have to investigate the other policy options available to it.
Data released for Australia the week highlight the need for further support for our economy. Retail sales rose a disappointing 0.1% in May to be essentially unchanged over two months. In the detail, there was evidence of declining wealth restricting large discretionary purchases, though evidence of a wealth effect for smaller purchases was mixed.
While house prices declines look to have come to an end in Sydney and Melbourne, falls were seen elsewhere in June. Even for Sydney and Melbourne, the base case is only for flat prices or small gains, hence wealth considerations could continue to affect consumption for some time. Weak house prices are also likely to keep a lid on approvals and residential construction hence. While dwelling approvals beat the consensus expectation in May, the detail was weak, with only the volatile high-rise component showing strength.
Thankfully, support for the economy is also set to come from the Federal Government, following passage of their three-stage tax package through Parliament. We do not see this package as a game changer for consumption given it first comes as a rebate and subsequent tax cuts come with a considerable delay. However, in combination with RBA rate cuts, the tax measures should at least stabilise growth, laying a foundation from which a hoped-for acceleration in infrastructure investment could drive growth back to trend.
Shifting our gaze offshore, last weekend’s G20 brought the market what it had hoped for and a little more, with President Trump suspending a threat to broaden the array of goods that US tariffs apply to; agreeing to new negotiations with China; and also walking back the restrictions imposed on Huawei. Our assessment of the implications for China can be found in the July edition of Market Outlook, along with an updated read on the US economy, Europe and global currency markets.
On the US, the point to highlight here is that market participants have been unwilling to let go of their call for the FOMC to, at the very least, cut the federal funds rate by 25bps at its July meeting. While we see no immediate need for the FOMC to act based on the data to hand, to ‘get ahead of the curve’ and for the sake of confidence, we now see July as the most appropriate date for the Committee’s first cut. After that, another cut is to follow in the December quarter, as data and risks dictate.
In Europe, a decision was finally made on political leadership nominations almost six weeks after the May European Parliament election. For the first time, women will hold the two most powerful positions in Europe – Christine Lagarde will head the ECB, and Ursula von der Leyen the European Commission.
Lagarde’s appointment is reassuring to many given her successful political career and tenure as Managing Director of the IMF during the European debt crisis. The decision on von der Leyen is slightly more contentious given her mixed track record as German Defence minister. Her immediate task will be to take over from Juncker in handling the dispute with the Italian government around budget prudence for which, at least for now, tensions have eased after the EU decided against implementing disciplinary measures this week – the 10 year BTP-Bund spread falling back to just over 200bps as a result.