Since our last update the RBA has delivered a third rate cut in Ocotber and held steady in November as we forecast, taking the cash rate to a new record low of 0.75%. The minutes of the November monetary policy meeting revealed that the board weighed further easing but held off on the basis of waiting to asses the impact of prior easing and also noting the impact on confidence of rate cuts to date as a deterrent. But based upon the RBA’s own forecasts and (lack of) attainment of mandated targets it is likely that further policy easing is in the pipeline taking the cash rate to a further record low 0.50%.
Inflation remains stubbornly low and the labour market has continued to deteriorate, for the RBA to meet its mandated inflation target and full employment goals further stimulus measures will be needed. Of course, the debate surrounding the effectiveness of monetary policy could be inserted here but for the purpose of this article it is more useful look at what central banks will do, not what we think they should do. In this case the RBA don’t have many options in a toolbox of blunt instruments. So, it is likely they will continue to use monetary policy to try to achieve better growth outcomes regardless of whether monetary policy is reaching the limits of its effectiveness. In addition, the Australian governments fixation on returning the budget to surplus and limited appetite for implementing a complementary fiscal stimulus package leaves the RBA doing the heavy lifting with respect to the Australian economy. This is also adding to the case for further easing and taking the cash rate further towards the effective lower bound which Governor Lowe has previously earmarked as 0.25%-0.50%.
Wage growth MIA, Consumption Pressure Remains
October’s Labour Force Survey delivered another blow for the RBA, posting the weakest monthly survey in 3 years, with employment falling by 19,000 and unemployment rising to 5.3%, reversing the 0.1% fall to 5.2% the month prior and well above the 4.5% needed for the RBA to satisfy its objective of full employment. The participation rate which refers to the total number of people who are currently employed or in search of a job (the labour force) as a percentage of the working age population fell to 66%. Although notoriously volatile, the data add to our view of the labour market continuing to soften in coming months. We continue to expect the unemployment rate to drift higher as the construction cycle downturn spurs job losses and several quarters of below trend growth and weak demand will weigh on employment growth in coming months. This will make it increasingly difficult for the RBA to meet their objective of 4.5% unemployment, by their estimates the theoretical level of unemployment below which inflation would be expected to pick up, hence the door is open for continued easing.
Looking under the bonnet, substantial spare capacity remains an ongoing issue for the RBA preventing material upward pressure on wages. This is especially problematic for overindebted Australians struggling to maintain spending against a wall of household debt with the savings rate at a decade low. A dynamic that will continue to pressure the consumption outlook regardless of a recovery in the housing market. Underutilisation, a broader measure of spare capacity than the unemployment rate, including those unemployed and underemployed rose to 13.8%, well above the level needed to spur wage inflation.
Spare capacity in the labour market will continue to prevent upward pressure on wages and prices from materialising and weigh on the outlook for consumption. The longer that inflation remains below target, the more of a concern this becomes for the central bank as future inflation expectations play a role in current materialised inflation. Hence a persistent undershoot of the inflation target can risk de-anchoring inflation expectations making it harder to meet the inflation target in the future.
Against the backdrop of labour market spare capacity and stagnating incomes the current low growth environment that Australia has seen since the economy lost momentum last year will be sustained for a prolonged period whilst the outlook for consumption remains under pressure. Although the worst may be over we continue to expect growth to remain below trend throughout the year ahead. The rate cuts already delivered by the RBA along with the tax cuts are to date having a limited effect and consumers are choosing to add to precautionary savings and deleverage given wage growth is weak and household debt levels remain high. And although housing prices have risen in the last few months any positive wealth effect is lagging given household debt levels remain high and consumer confidence also continues to trend lower plaguing the potential for private demand to pick up.
Governor Lowe on Unconventional Monetary Policy
Against this backdrop it is no surprise why Lowe’s speech tonight (‘Unconventional Monetary Policy: Some Lessons from Overseas') is awaited with bated breath. With the lower bound approaching, further rate cuts on the way, the conversation naturally turns to unconventional monetary policy. Although given the title listeners waiting for a roadmap of unconventional monetary policy in the Australian context may have to wait for the Q&A.
The speech is likely to reiterate previous comments from Governor Lowe and other board members about why the use of negative interest rates is unlikely. And conversely reiterate the Governor’s prior thoughts that the engagement of unconventional monetary policy tools is also unlikely. Although hopefully there is an outline of what the RBA’s preferences and options would be, should the situation arise. The speech is also likely to lambast the government once more and highlight that a combination of both fiscal and monetary policy would be most effective in reigniting the Australian economy.
Westpac hit engulfed by money laundering allegations
It seems no Australia Update is complete without another Australian bank scandal. Westpac, being no stranger to scandal over the past 24 months, the biggest surprise has been the delayed CEO resignation and board changes. The news of the CEO, Brian Hartzer’s resignations has eased investor nerves somewhat today but unfortunately the problems are bigger than a couple of board changes and there is likely more pain ahead. The allegations of indifference stemming from senior management harp back to a resounding finding of the royal commission which highlighted the pervasive culture of greed and regulatory indifference entrenched across the industry, stemming from upper management and permeating right through the Australian banking system. This presents a far more broad-reaching problem which spans the entire sector and is lacking any easy or quick solution.
The magnitude of the penalty and any other repercussions is unknown at this stage but given the quantum of the laundering scandal and seriousness of the allegations relative to prior breaches it is sure to be sizable. This lends itself to the potential for further EPS downgrades and share price pressure as the story unfolds.