The RBA has openly discussed the risks from very low rates and points out that other policies can follow.

The Reserve Bank has released its quarterly Statement on Monetary Policy (SMP). The two key areas of most interest in the Statement are around further policy insights and the RBA’s growth, unemployment and inflation outlook.

The discussion on policy was particularly interesting. The Overview for the Statement, which we expect largely reflects the Governor’s own views, provides the most open analysis of policy options that we have seen. In outlining the policy decision in October, the Overview noted “the Board was mindful that rates were already very low and that each further cut brings closer the point at which other policy options come into play”. This represents a more open approach to the discussion around unconventional policies. To date, that discussion has been characterised by comments such as “unlikely”, whereas this wording indicates almost an automatic move from cash rate policy to other policy options. To be sure, there is no firm commitment to move in that direction but the wording indicates that such a transition to other options may be considered to be a normal approach to policy.

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Other issues around a very low cash rate, including that it may “unintentionally convey an overly negative view of the economic outlook” and “the usual channels of policy transmission might be less effective”, also signal that the cash rate cut cycle is nearing an end. That said, lower rates are seen as having some impact. Indeed, the usual channels of lower exchange rate and boosting household disposable income are pointed out. However, a new channel, “higher asset prices”, has been added to the list. Arguably, given that Sydney and Melbourne house prices bottomed out in May, the June and July rate cuts played a significant role in turning those markets. It is of some interest that the SMP highlights this channel as a constructive aspect of interest rate policy.

Commentary on the current policy position signals that rates are almost certain to remain on hold at the December Board meeting. Since the decision in November was part of a plan to allow time to assess the effects of the recent easing of monetary policy as well as global developments, no doubt the RBA’s observation that the low point in global pessimism may have passed is an important aspect of the current policy standing.

On balance, Westpac believes that its assessment that with the unemployment rate still well above the RBA’s target (4.5%) and the RBA seeing that there is a balance between the benefits and costs of lower rates, our view that 0.5% is the effective lower bound and that some transition to unconventional policies is likely is supported by this SMP.

The second point of interest in the SMP is around the RBA’s forecasts. As we anticipated in our preview to this SMP, the key growth forecasts for 2020 of 2.8% which was adopted in August, has been retained in this SMP. That is much higher than Westpac’s forecast of 2.4%. Surprisingly, the forecast in November includes a more optimistic outlook for dwelling construction for 2020 (-2.6%, upgraded from -3.3%) and business investment (+6.2% upgraded from +5.8%). Partially offsetting that more optimistic view is the lowering in growth of public demand from +3.2% to +2.9%. These forecasts for 2020 contrasts with Westpac’s forecast of 2.4% for GDP growth, -6% for dwelling investment, and +2.8% for business investment. Overall, Westpac’s forecast for growth in GNE of 2.3% in 2020 compares to 2.8% from the RBA. Looking further out, the RBA has retained its optimistic growth forecast for 2021 of 3.1% compared to our forecast of 2.7% with a substantial part of the difference being explained by the RBA seeing a much more rapid recovery in the dwelling investment cycle.

This substantial difference between Westpac and the RBA on the construction cycle partly hinges around the link between established house prices and construction activity. Furthermore, even the RBA points out that the current expected pipeline of construction may be overstating actual activity.

There have been some modest downward revisions to the inflation and wages outlook. Even though the unemployment rate profile of 5.2% in December 2020 and 4.9% by December 2021 is unchanged from August, wages growth for December 2021 has been cut from 2.4% to 2.3% (“wages growth is no longer expected to pick up”) and growth in the trimmed mean inflation measure has been cut from 2.1% to 1.9%. It must be particularly uncomfortable for the RBA to be forecasting that underlying and headline inflation will remain below the bottom of the 2-3% target band right out into 2021.

Readers will be aware that on November 6, Westpac advocated the bringing forward of the legislated personal income tax cuts, which had been timed for June 2022, to June 2020 and June 2021 (evenly distributed). If the Federal Government were to take up that policy option, then Westpac’s forecasts for consumer spending, housing activity and business investment will be lifted.

Conclusion

The November SMP provides the clearest insight yet into the RBA’s thinking about policy in 2020. The acceptance that, after rates reach a certain threshold, other policy options “might come into play” is quite significant. The recognition that asset prices are an additional channel of monetary policy and are assessed to be a positive channel is also important.

The overview of the RBA’s growth outlook, while largely unchanged from August, still appears to be overly optimistic, particularly around the residential construction cycle and business investment. On the other hand, the downbeat view on wages, inflation and the unemployment rate make it clear that the RBA does not believe that its job is done and so we can expect further policy action from the RBA in 2020. Westpac continues to expect the RBA to cut to 0.50% in February 2020 and to move to unconventional policies at an appropriate time.

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