Having just returned from two weeks in the US visiting clients and government officials, two themes were clear.
Firstly, the about-face from the US Federal Reserve late last year led to much discussion after markets revised their expectations on rate hikes, believing the tightening cycle has finished. The December sell-off in the sharemarket, trade tensions between the US and China, the government shutdown and general concerns about global growth contributed to this shift.
My view is that may be a little optimistic, but the Fed may take some time to build the case for further increases in the Fed Funds Rate. We now expect one more hike in December.
The international investors were also interested in what is happening in the Australian housing market and the weakness in the past 12 months is starting to impact their thinking about the economy. Likewise, the Reserve Bank has recently gone from a tightening bias to saying the next move in the cash rate may be up or down following falling house prices in Sydney and Melbourne and the spill over on consumers.
This week, the minutes of the Bank’s board meeting for February showed that while the effect of recent price falls on overall economic activity was expected to be relatively small, a very significant warning was inserted that “if prices were to fall much further, consumption could be weaker than forecast, which would result in lower GDP growth, higher unemployment and lower inflation than forecast”.
This statement directly links developments in house prices to the Bank’s key policy forecasts. The causal mechanism would be around a larger “wealth effect” than expected, impacting consumer spending and a sharper downturn in residential building activity. There is mixed evidence around wealth effects in other countries although the scale of the adjustment in house prices in Sydney and Melbourne is too large to downplay.
For the record, the RBA this month lowered its GDP growth forecast to 3 per cent for 2019 and 2.75 per cent for 2020, largely due to softer consumption growth and a sharper downturn in dwelling investment.
Westpac has long argued that the RBA’s previous growth forecasts were too high, and indeed, we have today downgraded our forecasts for both 2019 and 2020 from 2.6 per cent to 2.2 per cent.
Westpac now expects the Reserve Bank to cut the cash rate by 25 basis points in both August and November this year.
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