Macro 5 minutes to read

RBA holds rates steady. Again.

Eleanor Creagh

Australian markets strategist, Saxo Bank

Summary:  The Reserve Bank of Australia has held its key policy rate stock still for over two years now but gathering economic headwinds suggest it may be backing itself into a corner.


The Reserve Bank of Australia kept its cash rate unchanged at 1.5% today, as expected, having held it steady at that level for the past 27 consecutive board meetings. Despite continuously missing its 2%-3% inflation target range over the past three years, tepid wage growth and heavily overleveraged Australian consumers, the RBA maintains a stubborn optimism that the labour market will strengthen and inflation will return to its target range, allowing it to lift interest rates.

After dependably overpromising and underdelivering, you could be forgiven for thinking that the interest rate decision has become a bit of a snooze fest.

Housing

To a certain extent that would be a fair assumption to make. But now the storm clouds are gathering over the domestic economy and because investors are losing faith in the RBA’s confidence that the next move will be up, this week’s commentary from the central bank was keenly anticipated.

Financial markets are not buying the RBA’s stoic narrative and are pricing in a greater than 50% chance of a rate cut by the end of 2019. Since we last heard from the RBA in November, it is clear that the domestic economy has lost momentum.

In the last 24 hours alone, a slew of economic data has highlighted the downwards pressure on the domestic economy. 

Retail sales have contracted in December, highlighting the potential pullback in consumption from over-indebted households grappling with falling house prices. Of note, large falls in retail sales were seen in NSW and Victoria, where the epicentre of the housing market declines have been felt, suggesting the negative wealth effect is in full swing. 

Imports fell 5.7% in December, posting the largest one-month fall on record. Capital goods imports fell 15%, consumption goods imports contracted 7% and intermediate goods imports contracted 6%, likely a reflection of a broad-based weakening of aggregate demand.

ANZ job advertisements fell in January, a leading indicator that points to a potential drop off in hiring ahead, consistent with our view that economic growth is deteriorating and will continue to do so throughout the year. The official unemployment rate fell to 5% in December and is now sitting at cycle lows, but it must be remembered unemployment is a lagging indicator, so the data only gives us a rear mirror view on the health of the labour market.

And it doesn’t stop there, building approvals slumped for the second month running with the YoY decline now reaching 22.5%. This slowdown highlights a marked decrease in residential construction to come and another leading indicator pointing to potential weakness in employment in residential construction. Yet another indication that a substantial tightening in credit is having knock on effects to the real economy and will continue to weigh. 


The housing market has continued to feel the heat with Sydney and Melbourne seeing accelerated falls. Sydney property prices are already down 12% from their July 2017 peak and with the banks’ continued credit constriction and the economy decelerating, these falls are likely to intensify. 

It is only a matter of time before jobs are affected, a decent chunk of the labour force is in some way related to the property market; not just in building and construction but lawyers, accountants and real estate agents etc. In the year ahead, we could see another 15% of price declines, we are seeing 12% falls in Sydney house prices whilst unemployment is holding up, once the economic slowdown becomes more evident and unemployment rises, confidence will fall further, and prices could overshoot to the downside. The housing slowdown will also feed back to the real economy through the negative wealth effect and weigh on overleveraged households’ consumption. As has already been evidenced by the falls in car sales, weak household spending in the Q3 GDP report and today’s retail sales data. 

With clear downward pressures emerging for the Australian economy it is evident that the RBA’s outlook is in jeopardy, as we have previously highlighted.  Against the backdrop painted above. it would be reasonable for the RBA to drop its mantra that inflation will return to the midpoint of its 2%-3% target range and that “the next move is up”. But this rhetoric seems now so entrenched that the RBA appear more like a college teenager clinging on to the memory of an ex-girlfriend.

In today’s board meeting statement, the RBA maintained its view that inflation would eventually return to target, albeit at a slower rate, indicating that monetary policy easing is unlikely. Forecast growth was revised down to 3% for 2019, still too optimistic in our view. But as we highlighted after December’s weak Q3 GDP report  this downwards revision really just encompasses the minimum requirement, as dictated by incoming data. 

As we have previously noted, the strength in the labour market with unemployment at cycle lows has given the RBA bandwidth to maintain that a strengthening labour market will offset the potential hit to consumption from declining house prices, thus securing a soft landing for the Australian economy. This is evidenced by Governor Lowe’s comments in today’s statement, “Growth in household income has been low over recent years, but is expected to pick up and support household spending.” In our opinion, as outlined above, the recent data has continued to confirm that this is unlikely to be the case. Although whilst employment remains at a cycle low the RBA is unlikely to fully capitulate on policy guidance in, given the optimism which has prevailed for so long. 

To give credit where it is due, the RBA seems less at ease than previously with the current economic outlook, highlighting that “downside risks have increased”. This subtle shift will continue to emerge as the year progresses and the economy deteriorates. The incoming data over the last 24 hours alone are inconsistent with the central bank’s outlook, confirming the risks are stacking up and a future slowing of growth seems inevitable.

The dichotomy between the labour market and economic environment will not persist. In 2019 the economic growth will rebound or the labour market will deteriorate, our bet is on the latter. In our view, the RBA will find itself backed into a corner where a rate cut is unavoidable.
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