RBA’s Debelle strikes optimistic tone; remains lazer focused on the state of the labour market
We had warned to watch out for dovish noises from the RBA this week after it changed its monetary policy meeting statement earlier in the month to say they are monitoring developments, suggesting they may be willing to consider a rate cut in coming months if downside risks to growth materialize.
However, the speech on the “State of the Economy” on Wednesday by Deputy Governor Guy Debelle sounded relatively optimistic that the deterioration in the outlook since mid-2018 both in Australia and globally may be temporary. The RBA is more watchful, but not yet ready to cut rates.
Debelle highlighted risks to the Australian growth outlook including the clampdown on shadow financing in China and trade tensions, slower household consumption in Australia and a weaker housing market.
However, he sounded more optimistic on the state of the global economy than many market commentators, noting ongoing strength in service sectors and employment and wage growth (globally and in Australia).
He tended to downplay the negative influence the housing market decline may have on the Australian economy.
He suggested that the RBA is lazor focused on the labour market. Provided employment growth continues, unemployment declines and wages growth accelerates, the RBA is unlikely to cut rates. At this time, the RBA still sees strength in leading indicators of the labour market, even though job ads have fallen in recent months. It appears to prefer the vacancy data that rose to a new high in February from three months earlier.
Understandably, in response to Debelle’s glass half full speech, Australian rates and the AUD have firmed.
It is fair to predict that the RBA will cut rates later this year, as most market economists have done. However, Debelle and the RBA are not yet convinced this will be necessary. In particular, it appears to need evidence that the labour market is losing momentum, and this may take several months.
Global tension between labour and GDP data
Debelle acknowledged the pronounced slowdown in manufacturing industries globally, but noted that “The slowdown is not as marked in surveys of business conditions in the services sectors.” And that, “in many economies, including Australia, the services sector accounts for well over half of the economy.”
A key point in his speech, and one that was first made by the RBA Governor Lowe in February, is that both in Australia and several other major economies, the sharp slowdown in GDP growth in H2-2018 was not matched by weaker employment growth. And employment growth has continued at a solid rate into 2019.
Debelle and the earlier speech by Lowe, emphasise that the RBA is waiting for this tension between the labour data and GDP to be resolved before deciding on its next policy move.
Debelle tended to downplay the notion that labour growth may be a lagging indicator. He asked, “why are businesses still continuing to hire people in the face of a slowdown in growth that started over six months ago.”
He noted that in Australia, and several other major economies that wage growth is picking up in response to tighter labour markets. He said, “The pick-up in wages has taken longer and been more gradual than expected, but it is happening now. Wages growth is currently running above 3 per cent in the United States, the United Kingdom and Germany. In each case, this is the highest pace of wages growth in around a decade. In Japan, wages growth is in positive territory.”
A key to sustained growth is that stronger employment and wage growth drive income growth and household consumption growth. While the RBA continues to see tightening labour markets, especially in Australia, and rising wage growth, it appears willing to hold back from interest rate cuts.
Risks from China and trade disputes
Debelle pinned much of the recent weakness in global manufacturing on the “the clampdown on shadow or non-bank finance” in China that has “particularly affected the private sector in China, which has been an important engine of growth.”
He also blamed the “the escalation in trade tensions”. But not so much the direct effect of tariffs, more so the uncertainty over the form and durability of any US-China trade deal that may be struck. This uncertainty, he thought, is likely to be delaying business investment globally. He said, “The slowdown in investment spending has affected economies along the supply chain, including Germany.”
The risks to the global economy emanating from both China’s shadow finance sector and trade disputes remain significant. Debelle noted that China has made efforts to stimulate growth and unlock financing to the private sector, but acknowledged doubts that the state-owned banks in China could effectively direct finance to the private sector. He said, “the effect of this stimulus may take a little while to become apparent.” Clearly, uncertainty over trade policy lingers.
Not fearing the yield curve
Debelle largely dismissed fears that the recent inversion of the US yield curve might portend a recession. He said, “Historically, this [term ] premium in the United States has averaged around 150 basis points. If that was the premium today, the yield curve would be a fair way from inversion. Secondly, in the past, the yield curve has inverted when the policy rate has risen into clearly restrictive territory. That is not obviously the case today. Thirdly, as I just mentioned, credit spreads are tightening. This doesn’t normally happen as the economy slows.”
The critical factor is the labour market
On the Australian economy, Debelle acknowledged that household consumption growth over the last year had been weaker than expected, and this was a significant concern. However, he also noted strength in non-mining business investment and export growth.
Debelle said that the RBA “continues to pay close attention to the housing market developments”, but it is not displaying the same fears that many in the market have that the downturn in the housing market is or will drag down the rest of the economy.
The critical factor for the RBA is the labour market. If that continues to strengthen it will tend to mitigate the dampening influence of the housing market, in the RBA’s assessment, on household consumption. Debelle reiterated the message from Governor Lowe in February that the negative wealth effect from lower house prices is negligible, and mortgages in arrears will remain low if unemployment remains low.
On the labour market, Debelle retained the well-worn RBA line that “forward-looking indicators of labour demand suggest future employment growth will remain solid.”
He said, “The job advertisement series have declined somewhat recently, but the ABS vacancy series, which surveys businesses about their current level of vacancies, remains at a very high level”
He acknowledged that business surveys have “declined from their high levels of the first half of 2018” but he said they “still remain consistent with around trend growth in the economy.” And, “This is also the sense I get from the Bank’s extensive business liaison program.”