Australian Market Strategist, Saxo Bank Group
Summary: The Reserve Bank of Australia has begrudgingly succumbed to the realities of the "lucky country's" slowing economy and today signalled that it is ready to fire on rate cuts.
The RBA have begrudgingly succumbed to the realities of the slowing economy, with pervasive weak inflationary pressures, consistently below target, and stagnant wage growth signalling today they are ready to fire on rate cuts.
This change of course means that after a prolonged period of weak inflationary pressure and stagnant wage growth, the central bank's hope that the labour market would strengthen and inflation would return to its target range, has been overcome by reality. In a speech today delivered to the Economic Society of Australia in Brisbane RBA Governor Philip Lowe gave a clear signal that rate cuts are coming and that their finger could be on the trigger as early as June.
Lowe referenced May’s monetary policy meeting where the RBA held back from cutting the cash rate, “Earlier today, we released the minutes of the Board's meeting two weeks ago. At that meeting, we discussed a scenario in which there was no further improvement in the labour market and the unemployment rate remained around the 5 per cent mark. In this scenario, we judged that inflation was likely to remain low relative to the target and that a decrease in the cash rate would likely be appropriate.”
Last week we saw that the unemployment rate has now increased to 5.2% in April, up from an 8 year low of 4.9% in February. Given the RBA has abandoned other indicators of economic health to explicitly tie the outlook for monetary policy to the labour market, reading between the lines a decrease in the cash rate should now be deemed appropriate by the RBA. Particularly as spare capacity also picked up and several leading indicators are pointing to a slowdown in hiring ahead meaning unemployment has the potential to further increase; ANZ job ads, the NAB business survey employment index, capacity utilisation, SEEK job ads also contracted 10% in April.
Lowe as good as confirmed this move in the denouement of his speech “at our meeting in two weeks' time, we will consider the case for lower interest rates.” We have long forecast that the RBA would be backed into a corner where rate cuts were inevitable but would not capitulate until the labour market deteriorated. With this now in play we expect the RBA to cut the cash rate by 25 basis points to 1.25% at its June 4 policy meeting. This would take the RBA's cash rate target to a new record low of 1.25%, after nearly three years on hold at 1.5%, following its last rate cut in August 2016.
Financial markets are in full agreement, and futures are now pricing a 91% probability that a rate cut is delivered next month.
The RBA also made a point to highlight that monetary policy is not the only game in town and called upon the government to increase spending. A message also to the senate crossbench not to obstruct and potentially delay tax cuts announced by the Morrison government in the April Federal Budget. Media channels have reported that these tax cuts are likely to be delayed until 30 June 2020 because parliament is unlikely to resume in time to pass the measures, despite the Australian Taxation Office saying otherwise.
“In the event that the unemployment rate does not move lower with current policy settings, there are a number of options. These include: further monetary easing; additional fiscal support, including through spending on infrastructure; and structural policies that support firms expanding, investing and employing people. Relying on just one type of policy has limitations, so each of these is worth thinking about.”
This plea from the RBA is not just reminiscent of the impotence of monetary policy fast approaching the zero-lower bound, but a wake-up call to the newly elected Morrison government. The downside risks stacking up against the Australian economy will not evaporate upon 50bps of rate cuts. 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.
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