After the Reserve Bank last week cut its forecasts for growth and inflation to barely acceptable levels despite assuming two rate cuts, attention has shifted to when the cuts will occur.
To recap, the forecasts laid out in the RBA’s May Statement on Monetary Policy were for GDP growth of 2.6 per cent for 2019 and 2.7 per cent for 2020, compared to 3.0 per cent and 2.7 per cent in February, mostly due to weaker consumption and dwelling investment.
We are not surprised that the RBA has now adopted our own view of the consumer and is also moving towards our forecast for the contraction for dwelling investment in 2019 of 9 per cent.
As revealed in the Governor’s decision statement following the May Board meeting, the underlying inflation forecasts (trimmed mean) have been reduced from 2.0 per cent for 2019 in February to 1.75 per cent in May and the 2020 forecast reduced to 2.0 per cent. The forecast unemployment rate has been slightly increased, with the 5 per cent unemployment rate still expected to hold through 2019 but the fall to 4.75 per cent pushed back six months to June 2021.
These forecasts are what we should call absolute “bare-essentials” – growth slightly below trend of 2.75 per cent and inflation only holding at the bottom of the 2–3 per cent target band out to the end of the forecast horizon. And given these forecasts are based on market pricing in two RBA cash rate cuts by May 2020, it seems clear therefore that the RBA now believes that it needs to cut rates to barely achieve an acceptable outcome.
We concur with the market’s August timing for the first cut but expect that the second cut will occur in November – well before the timing implied by market pricing of a full cut by May 2020. We have held this view since February.
A key issue is the labour market data, the RBA last week emphasising “the Board will be paying close attention to developments in the labour market at its upcoming meetings”.
It has been Westpac’s view for some time that the unemployment rate has already bottomed out at 4.9 per cent and we expect that it will gradually drift up through the second half of 2019 to around 5.4 per cent. We expect that trend to become clearly apparent by the June employment report (released in late July), making the first cut an obvious decision for the August meeting.
The risk remains that the RBA may choose to move earlier than August.
Although given the strong first quarter for employment growth and the notorious volatility of the monthly employment reports, it seems likely that a prudent central bank would wait until August for its first move – when of course it will be able to fully explain the move and support it with its revised forecasts in the next Statement on Monetary Policy.
This material contains general commentary, and market colour. This material does not constitute investment advice. This information has been prepared without taking account of your objectives, financial situation or needs. We recommend that you seek your own independent legal or financial advice before proceeding with any investment decision. Whilst every effort has been taken to ensure that the assumptions on which the forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The ultimate outcomes may differ substantially from these forecasts. Except where contrary to law, Westpac and its related entities intend by this notice to exclude liability for this information.
By Ben Young
Head of Fraud and Financial Crime Insights