Australian markets strategist, Saxo Bank
Summary: After a record 33 months on hold and having consistently missing even the lower bound of its 2%–3% inflation target, the relentlessly optimistic Reserve Bank of Australia finally cut the official cash rate from 1.5% to 1.25%, a new record low.
The move is an admission from Governor Lowe and the RBA board that their relentless motto that the “next move would be up” and excess capacity in labour market would be eroded prompting wages to rise thus returning inflation to target, was completely wrong.
The statement accompanying the move was noticeably short and somewhat bland, with no clear indication of whether this 25 basis point cut would be followed by another.
Given that the swaps market is looking for a terminal rate of less than 1%, with the current implied policy curve suggesting an implied rate of 0.81% by June 2020, it is fair to say the market has front run the RBA’s move considerably. Hence the brief move higher in AUDUSD and uptick in yields, as the market had already out-doved the non-committal verbiage of the accompanying statement.
The final paragraph of the statement reads “The Board will continue to monitor developments in the labour market closely and adjust monetary policy to support sustainable growth in the economy and the achievement of the inflation target over time”, this is carefully constructed to allow the RBA a degree of flexibility and data dependence. But this wording, in contrast to their stubbornly optimistic “next move is up” mantra, that only shifted very recently in the grand scheme of things, reads dovish. The focus will continue to be on the labour market, so traders eyes will be glued to the May data set for release June 13.
The main event will be tonight when Governor Lowe speaks in Sydney at 7.30pm AEST. The speech titled “Today’s Reduction in the Cash Rate” should provide more colour on roadmap for future rate cuts. Governor Lowe’s speech could be vital in deciphering when the RBA will follow up with a second 25 bps rate cut.
The RBA is also likely to call on the government to increase spending again tonight. Net government debt in Australia remains low relative to other countries, providing the newly elected government with plenty of ammunition to fire at the ailing economy.
The RBA’s plea will be a wake-up call to the Morrison government and potentially obstructionist senate that downside risks to the economy will not evaporate on rate cuts alone. Against a deteriorating global backdrop, and policy rate fast approaching the zero lower bound a coordinated response and focus on productivity reforms, infrastructure spending and other fiscal measures will be necessary to reignite confidence and a self-sustaining recovery in economic growth. Already policy makers are behind the curve on policy settings and risk a further disruption in confidence and self-perpetuating below trend growth if confidence is not restored amongst consumers and the business community.
Given that the forecasts in the May Statement on Monetary Policy were predicated on two rate cuts, 50 basis points by year-end should be an inevitability. However, it is hard to see just two rate cuts providing a material impact in returning inflation to target. Governor Lowe has previously stated “my judgement of the accumulating evidence is that the Australian economy can support an unemployment rate of below 5% without raising inflation concerns” and again in today’s statement noted the “Australian economy can sustain a lower rate of unemployment.” This signals that NAIRU is probably lower than 5% as previously thought and unemployment needs to fall substantially further before wage pressures pick up.
In April, we saw that the unemployment rate has now increased to 5.2%, up from an eight-year low of 4.9% in February. Spare capacity in the labour market also increased, another factor cementing anaemic wage growth and preventing inflationary pressures from materialising.
Underutilisation is a broader measure of spare capacity than the unemployment rate and this picked up from 13.3% to 13.7%. Underemployment (those employed but wanting to and available to work more hours), another measure of labour market slack, also rose from 8.2% to 8.5%, meaning nearly 2 million people in Australia have work but want to work more hours. Combine stagnant wage growth, labour market slack and deteriorating leading indicators of labour market health and it is likely the RBA will be cutting the cash rate again soon.
Household consumption can only be propped up by running down savings for a limited period of time, with heavily indebted consumers already struggling and an economy where household spending makes up roughly 60% of economic activity it is not hard to make the case for further rate cuts.