Next cash rate cut to occur in April, followed by second in August – as outlined last week.

The Reserve Bank Board meets next week on February 4.

As discussed in our last weekly Westpac now expects the Reserve Bank to delay its next cut in the cash rate to April with the final cut to 0.25% occurring in August. Prior to the release of the surprisingly strong December employment report we had expected the cuts to be timed for February and June.

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The inflation report, which printed on January 29, confirmed that inflation remains ‘stuck’ well below the Board’s 2–3% target band with the trimmed mean (the key measure of underlying inflation used by the RBA) printing 0.43% for an annual rate of 1.6%. The annual rate of increase of the trimmed mean has been within a 1.5%–1.8% range for the past four years. The RBA’s latest forecasts envisage the annual rate of the trimmed mean holding at 1.8% in 2020 and 1.9% in 2021. When the Bank releases its revised forecasts on February 7 we expect it will reaffirm that inflation outlook.

These are not the forecasts of a central bank (with a 2–3% inflation target range) that expects it has come to the end of its easing cycle.

Such a decision would only be appropriate if the Bank assessed that further easing in policy would be ineffectual or counter productive.

However, in its December minutes, the Board made the case for the effectiveness of monetary policy.

“Members discussed the transmission to the economy of the interest rate reductions since the middle of the year. They noted in particular that the available evidence suggested that more stimulatory monetary policy had been working through the usual channels of lower bond yields, a depreciation of the exchange rate and lower interest rates on mortgages. There had also been an effect on housing prices, increased housing turnover in the established market and some early signs of a stabilisation in housing construction activity …

… While members recognised the negative confidence effects for some parts of the community arising from lower interest rates, they judged that the impact of these effects was unlikely to outweigh the stimulus to the economy from lower interest rates”.

It is also important not to confuse monetary and fiscal policy. There has been some speculation that fiscal policy is the only answer. We accept that a more stimulatory fiscal policy is necessary and have strongly advocated the bringing forward of the Stage 2 personal tax cuts in two tranches beginning in July 2020 and followed by the second tranche in July 2021.

Based on the most recent fiscal update – the Mid-Year Economic and Fiscal Outlook, released December 16 – that policy would risk pushing the 2020/21 and 2021/22 fiscal positions back into modest deficits. We believe that such a ‘price’ is worth paying if we are to provide a sizeable boost to household incomes and an associated lift in business expectations for stronger demand growth.

Now, of course, it is necessary to superimpose on this discussion the recent exogenous shocks of the bushfires and coronavirus.

Westpac has adjusted its GDP forecasts for the bushfire effect, lowering GDP growth in both the December and March quarters by 0.1%, reflecting the impact on tourism; agriculture; and regional retail of the bushfire crisis.

The other likely effect was always going to be the overriding impact on consumer confidence. The Westpac-MI Index of Consumer Sentiment fell by 1.8% in January to 93.4 – a fairly modest fall compared to the 5.8% fall during the Queensland floods of 2011. However the survey was taken during the first week of rain in January, and the starting point for the Index was much lower than in 2011 (a reading of 111 for Sentiment).

The –0.2% growth impact is seen to be on the conservative side with estimates ranging from –0.1% to –0.5%.

We have also pencilled in a lift in demand of 0.1% of GDP later in 2020 to reflect the rebuild that will follow.

The second risk to the growth outlook is the coronavirus outbreak.

This virus is likely to largely affect Australia through its impact on services exports. This sector has been an important source of growth for the Australian economy. In a year (to the September quarter 2019) where the Australian economy grew by ‘only’ 2.0%, net service exports contributed 0.4ppts.

Services exports are about $100bn a year. This includes $64bn, 3.2% of GDP, in travel and education – of which Chinese students and tourists represent 27% of those exports, or 0.85% of GDP.

Consequently the direct effect of a complete shutdown of Chinese tourism and student travel for a year would reduce GDP by almost 1ppt with significant additional multiplier effects. However such an outcome is extreme – well beyond the experience during the SARS outbreak of 2003 – and we can only await a clearer picture of developments over the next few months.

Issues of importance in estimating the impact on Australia’s services exports include: the resilience of the virus; the impact on student travel and the impact on tourism.

Westpac has not imputed this effect in its current growth forecasts given the high degree of uncertainty.

The Reserve Bank will also be pondering the impact of the bushfires and coronavirus on its growth forecasts.

We will receive an update on the Bank’s growth forecasts on February 7, while the Governor is giving a speech “The Year Ahead” on February 5.

We expect that the RBA will lower its 2020 growth forecast from 2.8% to 2.6% (rounded down to 2.5% in the main forecast table in the ‘Economic Outlook’ section). That compares with Westpac’s forecast of 2.1% (no coronavirus effect included) and will be justified by the weaker than expected momentum in 2019 (September quarter GDP was not available for the November forecast) plus some allowance for the bushfires/coronavirus.

However these latter effects will be considered transitory and the ‘bold’ forecast of 3.1% growth in 2021 will likely be retained.

Markets should not feel that a lowering of the near-term growth forecast to below trend growth should automatically require a rate cut. The assessment of monetary policy involving ‘long and variable lags’ and an above-trend growth forecast in 2021 is sufficient to justify a ‘pause’ until the impact of exogenous shocks becomes clear and the sustainability of the recent downtrend in the unemployment rate can be tested.

Such an approach is entirely consistent with Westpac’s expectation that the next rate cut will be in April following the December quarter national accounts and the next ‘snapshot’ of Australia’s growth momentum.

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