RBA is unlikely to cut rates month but the forecasts which will be released will point to further action later in the year.

The Reserve Bank Board minutes for the July meeting have sent a clear message that the Board plans to pause in its easing cycle at the next meeting in August.

Following the release of the minutes I wrote: the best way to assess the likelihood of a move in August is to compare the wording in the June minutes with the wording in the July minutes. In the June minutes, the key “considerations” section noted “members agreed that it was more likely than not that a further easing in monetary policy would be appropriate in the period ahead”. This very strong sentence was not repeated in the July minutes.

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Furthermore the minutes do state that “the Board will continue to monitor developments in the labour market closely, and adjust monetary policy if needed”. In the June minutes, the “if needed” qualification was not used, merely saying instead “members agreed that in assessing whether further monetary easing was appropriate, developments in the labour market would be particularly important”.

Finally, my experience is that when a central bank decides to pause, it often refers back to previous policy decisions. In the final paragraph of the July minutes, the Board notes “this decision, together with the reduction in the cash rate decided at the previous meeting, would assist in reducing spare capacity in the economy”.

However there will be considerable interest in the forecasts which the RBA provides in the Statement on Monetary Policy that will be released on August 9 following the Board meeting on August 6. Whilst these forecasts are not expected to trigger an immediate policy move they will be very important for the policy profile over the next few months.
When the RBA last released forecasts in May it forecast that real GDP growth would be 2.75% in both 2019 and 2020.

Note that the May forecasts were based on market pricing for the cash rate which, at the time, discounted two 25 basis point cuts by year’s end.

The cuts were delivered earlier than market expectations at that time and the market is now pricing another move by year’s end. As such there is some justification for lifting the May forecasts, although more recent developments are much more important for comparing the May and August forecasts.

Since then the national accounts printed growth in the March quarter at 0.4%. Based on the RBA’s forecast for growth to June 2019 of 1.75%, we assess that they were expecting growth in 2019 H1 of around 1.25%.

That forecast is now likely to be lowered to 1% for 2019 H1. Consequently the RBA is now likely to lower the growth forecast for year to June 2019 to 1.5%.

However they are still likely to forecast growth in 2019 H2 at 1.5% meaning a downward revision to growth in 2019 of only 0.25% from 2.75% to 2.5%.

The forecast lift in momentum between H1 and H2 will be justified on the basis of the stimulus from the tax cuts, the cash rate cuts, and the return to stability in the housing market. All assessments are realistic although we would favour 1.25% rather than 1.5%.

The advantage of holding growth at 1.5% in 2019 H2 is that the 2019 result of 2.5% can justify a lift to 2.75% in 2020 confirming the Governor’s assessment that the economy will be growing around trend in 2020 – no change from the 2020 forecast in May despite the need to lower the 2019 forecast.

If the RBA had adopted our preferred 2.25% growth rate for 2019 then it would be a much bigger “stretch” to justify 2.75% in 2020.

It will be more difficult to hold to the May forecast of 2.0% for the underlying inflation measure (trimmed mean) in 2020. When the May forecasts were finalised the RBA was aware of the 0.3% print for the trimmed mean in the March quarter of 2019. As a result it was necessary to lower the 2019 forecast made in February from 2% to 1.75% and the 2020 forecast from 2.25% (comfortably within the 2–3% band) to 2%.

Westpac expects that the trimmed mean will print 0.3% in the June quarter (released on July 31) meaning 2019 H1 will be 0.6% for the trimmed mean. Under those circumstances it would be very difficult for the RBA to retain a credible forecast path of 1.75% (2019) and 2.0% (2020) for the trimmed mean.

It may decide to adopt a 1.5% (2019); 1.75% (2020) and 2.0% (2021) profile for the trimmed mean signalling that it will take even longer than previously anticipated to return to the 2–3% target band. As discussed we do not expect that move, in itself, would trigger an immediate rate cut. Yet in not eliciting a policy response, it would certainly cast further doubt on the RBA’s 2–3% inflation commitment.

The RBA has recently changed tack from emphasising growth and inflation to targeting unemployment. This is partly due to its frustration with the stickiness of wages growth. A tighter labour market is expected to boost wage pressures, which then lifts consumer spending, and thus pressures inflation through both higher costs and a narrowing output gap. The Governor has discussed a reasonable target of 4.5% for the unemployment rate.

Back in May the forecasts for the unemployment rate were 5.0% (December 2019), 5.0% December 2020, and 4.75% (June 2021). Since then unemployment has drifted up to 5.24% in June. Note that we expect the RBA will be forecasting growth in 2019 (H2) at around 3% (annualised) and 2.75% in 2020. This is only slightly above trend in 2019 (H2) and at trend in 2020.

Trend growth is not sufficient to lower the unemployment rate, challenging the RBA to raise its forecast for the unemployment rate in 2020 to 5.25%.
That is a long way from the Governor’s desired 4.5% target.

Such a forecast certainly justifies our call for another rate cut and intensifies our expectation (which we highlighted in our note in May) that risks to the 0.75% target rate were to the downside.

The vulnerability of the unemployment forecast also requires a very realistic expectation that the RBA will not wait until November to deliver the next move with every meeting after August likely to be very much a live meeting.

If we concede that the risks to our 0.75% “bottom” to the cash rate are to the downside, the issue becomes one of what is the realistic lower bound for the cash rate?
Issues to be considered are the effectiveness of policy, noting that the RBA sees the two major channels of stimulus coming through a lift in disposable income for borrowers and the currency.

The first two cuts in this cycle have been quite effective with an average of 45 basis points of pass through. The effectiveness of the next cut – which we confidently anticipate – will be an important indicator of likely future moves.

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