The Reserve Bank of Australia will next meet on Tuesday the 1st of November to vote on monetary policy with almost no expectations of any change to the current record low 1.50% cash rate. The implied probability calculated from interest rate futures suggests only a 19% chance of a rate cut at the next meeting, but have we likely reached the low point in rates? It’s always difficult as we don’t have a crystal ball and so much can change in such a short period of time with global growth remaining weak and fraught with key event risk, and sentiment can change in a heartbeat. This article aims to provide a brief overview of some of the key factors that will contribute to the decisions on monetary policy.
Looking at the data it makes sense for the RBA to remain in a “wait and see” mode as the impacts of 50 basis points in rate cuts earlier this year continue to make their way into the economy. At the moment there is no sense of urgency where the RBA would need to lower rates in November, however I firmly believe there is the scope to lower them in 2017 unless we see a sustained pickup.
Quarterly inflation data released on Wednesday at 11:30am AEDT will provide further insight, forecasts are for an expansion of +0.5% (QoQ Q3) up from the +0.4% previously. Year-on-year inflation is expected to be +1.1% up from 1% the previous quarter however well below the RBA’s 2-3% inflation target. The chart below highlights the pickup following a deflationary scare for the March quarter which saw the RBA act immediately to lower rates by 25 basis points. What we will be looking for in Wednesday’s inflation readings is further confirmation inflation is trending in the right direction or at least remaining stable around +0.5%.
Source: Tradingeconomics.com, ABS
New RBA Governor Phillip Lowe has publicly stated that the RBA are “not inflation nutters” and that more factors than just inflation are considered. At a recent speech at an event hosted by Citi Group he stated that “achieving the quickest return of inflation back to 2½ per cent would be unlikely to be in the public interest if it came at the cost of a weakening of balance sheets and an unsustainable build-up of leverage in response to historically low interest rates”. This clearly gives the impression that the RBA is in no hurry to act, unless something dramatic happens. Looking to Wednesday’s inflation figure it would take quite a disappointing reading to prompt the RBA to act urgently, likely a reading to close or below zero.
A deterioration in the labour market would certainly prompt action from the RBA with Lowe stating that “the case for moving more quickly would be strengthened in a world where the labour market was deteriorating and people were having increasing difficulty finding jobs”.
The chart below highlights the headline unemployment rate, having peaked at 6.3% in 2014 it has been declining steadily.
Source: Tradingeconomics.com, ABS
The latest unemployment figures released by the Australian Bureau of Statistic showed that on a seasonally adjusted basis month-on-month in September employment decreased by 9,800. Over this period full time employment declined by 53,000 while part-time employment increased by 43,200. This has been a trend we have witnessed over the past year, a fall in full time employment and an increase in part-time employment. This reflects a number of factors including a changing economy that is more focused on service industries which tend to be more part-time focused as well as a decrease in mining investment.
Since December 2015 roughly 130,000 part-time jobs have been added while full-time employment has fallen by 54,100. The headline unemployment figure can be misleading in this sense, the next chart below shows what is known as the underemployment rate. This takes the unemployment rate and adds in those who are working part-time for economic reasons and would prefer full-time work. We can see over the past two years a divergence has begun to emerge as the headline figure moves lower while the underemployment figure is rising.
Source: ABS
Average hourly rates of pay also reflect this economic reality, that there is slack in the labour market. At a time where global growth remains weak people will be less demanding about their salary instead preferring job security. Another contributing reason for this low wage growth is likely a result of lower headline inflation, in part reflecting lower petrol prices and groceries thanks to increased competition in Australia. The impact of this is that workers are willing to take less pay increases given the cost of living expenses is not growing.
We can see this reflected in wage growth shown on the next chart which has steadily declined from modestly below 4% in 2011 to just 2.1% at the end of June 2016. Lower wage growth will impact on consumer spending and while slack remains in the labour market this is likely to persist.
Sources: Tradingeconomics.com, ABS
A very valid concern of the RBA is that there will be an unsustainable build up in leverage by households taking advantage of historically low rates. If you happen to live in Sydney, Melbourne or Brisbane you are perhaps witnessing this effect more than other cities, due to a lack of supply, low rates and high demand property prices are soaring. On average capital cities across Australia increased by 12.1% year-on-year through until June 2016.
Source: http://www.businessinsider.com.au/house-prices-in-sydney-are-still-rising-at-insane-levels-2016-7
Investors and owner occupiers alike are taking advantage of these low rates to take on debt and gain exposure to the property market. While the lower rates have made debt payments more affordable the chart below shows that debt as a percentage of household disposable income now exceeds 175%. These levels can very easily become unsuitable and place enormous pressure on households should rates rise.
Source: ABS, RBA
Helping to combat some of this build up are previous measures implemented by APRA on bank residential lending which sought to reduce the amount of interest only loans, to ensure strict debt serviceability standards were adhered to, to reduce high leverage loans and also to curb growth to investors below 10% year-on-year. However should concerns about instability grow then we could see more macro prudential changes implemented to address this, providing comfort for the RBA to ease rates further.
Overall it is unlikely the RBA will lower rates on November 1st as they continue to maintain their “wait and see” approach. On the 4th of November the RBA will also release its quarterly statement on monetary policy which will provide updated economic projections providing further insight for us. While there is no sense of urgency at the moment, unless we begin to see a sustained pick up in the coming months it is likely the RBA will need to lower rates at least once in 2017, perhaps even twice.
Originally published by Rivkin