RBA may tweak guidance

Posted on September 3rd, 2018

Last week we wrote that an “RBA rate cut may soon be back on the table.”  The RBA releases its monthly interest rate decision statement on Tuesday this week.  No one is expecting much change in the statement.  We agree that the RBA  is more likely to leave its statement little changed this month.  However, there is a significant risk that the RBA shifts its balance of risks from ‘the next move in rates in more likely to be a hike’ to ‘the next move in rates is evenly balanced between a hike or a cut’.  If the RBA does make this shift in guidance, it will be quite a shock to the market and likely to send AUD rates and currency significantly lower.


RBA forward Guidance

The monthly interest rate policy statement has not included the RBA’s expectation that “the next move in the cash rate would be more likely be an increase than a decrease“.

This guidance has appeared in the minutes of the policy meeting (released two-weeks later).

It first appeared in the April and May minutes, where the RBA said, “members agreed that it was more likely that the next move in the cash rate would be up, rather than down.

The RBA removed this guidance from its June minutes, raising some questions whether they still wanted to provide guidance towards higher rates.

But it returned in the July and August minutes in the form   “more likely be an increase than a decrease.

In the August quarterly Statement on Monetary Policy (SoMP), the RBA said, “Higher interest rates are likely to be appropriate at some point, if the economy continues to evolve as expected“.  A similar wording appeared in for the first time their May SoMP.

In any case, this guidance has not appeared in the interest rate decision statement, due tomorrow.  The RBA has said only that, “holding the stance of monetary policy unchanged at this meeting would be consistent with sustainable growth in the economy and achieving the inflation target over time.”

As such, it seems unlikely that they will change this message with limited new information since the August policy statements.

However, it’s not out of the question that the RBA acknowledges a shift in the balance of risks around their forecast in the interest rate decision statement this week.  If the RBA has decided that a rate cut is back on the table, it may feel it worthwhile, even necessary to inform the public as soon as possible, i.e. on Tuesday.

This might have the benefit of weakening the AUD and bringing down market rates and providing immediate support for the Australian economy.

We doubt that the market is seriously considering that the RBA would shock the market, especially after making a virtue of its policy stability.  But, in our mind, the risks have changed, and this should feature in RBA deliberations.  We see the probability of a such an inclusion in the statement in the 10 to 30% range, much more significant than the market.

While few may be looking for such guidance in the interest rate statement on Tuesday, there will be keen interest in what forward guidance is included in the minutes, if any at all, two weeks later.  If the RBA leave the guidance out (as they did in June), or more emphatically say that members now see an equal risk of an increase or a decrease, this would represent a significant downgrade in the balance of risks.

They could, for instance, base this on the increased turmoil in emerging markets, the prospect of more US tariffs on China, or more out of cycle increases in domestic mortgage interest rates.

Included in this list might be political uncertainty and ongoing falls in house prices.  However, the RBA is unlikely to wade into politics or risk spooking households by making too much of falling house prices.  But these factors might feature in the internal discussions at the RBA and influence their mindset in their policy statement.

Any acknowledgement of a shift in the balance of risks for rates would be significant and lead to a further fall in AUD market interest rates and exchange rate.


Emerging Market Turmoil

Even if there is no mention of guidance in the interest rate decision statement, the RBA could include elements in the statement that highlight these additional risks.

The most obvious element that the RBA could add to its statement is an acknowledgment of risks to global growth and financial stability arising from the recent upheaval in several emerging market economies since its August policy statements; including in particular Turkey and Argentina.   Italian bond markets have also deteriorated further.


Increased trade policy risks

News reports last week suggest that the Trump administration plans to move ahead with tariffs on an additional  $200bn of Chinese goods.  In early August, news reports suggested that the Trump administration was considering setting these tariffs at 25%, up from an initially proposed 10%.

News reports from last week suggest that Trump wants to move ahead with these additional tariffs as soon as the public-comment period concludes on Thursday, 6 September.  As such these tariffs may be announced later this week.

In their August policy minutes, the RBA said, “Although the direct effects of trade protectionism measures that had been implemented and further measures that had been proposed were expected to be small, the broader risk of adverse effects on investment decisions and confidence had increased.”

The RBA discussed the possibility of an escalating trade war in their quarterly August SoMP.  They mentioned the possibility of tariffs on an additional $200bn of Chinese goods (on top of around $50bn of Chinese goods on which tariffs have already been implemented  ($34bn in early-July, and $16bn in late-August). And tariffs on steel and Aluminium announced in March.

The RBA anticipated the $16bn tranche, even though it was not yet implemented before the release of their Augusts SoMP.  However, it probably hadn’t, at that time in August, considered the possibility that the tariffs on a planned $200bn of Chinese exports to the US might be applied at 25% (more than double the initially proposed 10%).

In the August SoMP, the RBA said of the additional $200bn, “The direct impact on global GDP growth will be larger but still relatively modest. However, if such an escalation significantly affected business decisions, the adverse effects on the real economy could be more significant.”

Trump is moving as he said he would, and appears on track to, very soon, add on new tariffs at a larger rate.  He has also dismissed the Eurozone’s offer of zero tariffs on autos, contributing to weaker European equities.  Chinese equities and currency have been relatively stable in August, but remain well down on the year.

While progress towards a NAFTA deal has been made, this is cold comfort for other nations.  The NAFTA dealings in fact highlight that the US administration is making it tougher on other nations trying to trade with the North American block.

Australia’s fortunes are much more tied to developments in Asia, where Trump’s tough trade policy are generating the most significant risks to growth.

Perhaps the RBA will avoid saying much more on trade at its statement this week, waiting to see what unfolds in the coming weeks before shifting its view.  But it may choose to step up its concern.

In their July and August interest rate decision statements the RBA said, “One uncertainty regarding the global outlook stems from the direction of international trade policy in the United States.”  The RBA could choose to highlight that planned US tariffs pose an increasing threat to the global economy, especially to Australia’s key trading partners.


Political Risk

The RBA is unlikely to comment on domestic politics, but the change to a new PM, ditching of the National Energy Guarantee (NEG) policy, and weaker polls for the ruling Liberal-National Coalition may dampen business confidence and investment in the lead up to the next election that is coming into view.  It is likely to be held before 18 May 2019, when a half Senat election must be held by.

Political risk is also a factor abroad.  It is apparent in several emerging market economies, contributing to upheaval in the last month.  It is elevated in the UK as the Brexit timetable heats up, it is a factor Italian budget decisions slated for October, and it is rising in the US as the mid-term elections approach in November, and president Trump faces legal pressure and talk of impeachment.  For instance, Trump is more likely to play hardball on Trade in the lead-up to the US Congress elections.


Higher Mortgage rates.

In August, the RBA expanded its commentary on higher effective rates in Australia, but tended to downplay this concern. It said, “In Australia, money-market interest rates are higher than they were at the start of the year, although they have declined somewhat since the end of June. These higher money-market rates have not fed through into higher interest rates on retail deposits. Some lenders have increased mortgage rates by small amounts, although the average mortgage rate paid is lower than a year ago.”

In the last month, bank funding costs haven’t changed much,  but the key is that they remain elevated, even as US LIBOR-OIS spreads have eased.  The persistence of these higher funding costs led to one of the four major banks, Westpac, to lift is variable mortgage rates by 14bp.  It seems only a matter of time before all major banks raise their rates.  More smaller lenders have followed suit in the last month.  The RBA may choose to comment that mortgage rates have increased in the last month.


Waiting for GDP

One reason why the RBA may not make any change in its policy guidance this month is that there has been limited new information on the economy, and the RBA is waiting for the Q2 GDP report to be released on Wednesday.  There has been little direct effect on the economy yet from global risks.  Surveys of business conditions have waned somewhat from earlier in the year.  The capital expenditure survey released last week showed weaker investment than expected in Q2.

However, employment indicators have remained solid.  The unemployment rate has fallen to a low since 2012, wages growth has ticked up from record lows, retail sales have been decent, export revenues are stronger as the mining investment boom early in the decade is reaping benefits. The RBA is likely to maintain its view that “GDP growth is expected to average a bit above 3 per cent in 2018 and 2019.”


Weak housing market

The RBA has already acknowledged the slowdown in the housing market.  The pace of the fall in house prices hasn’t changed much in the last month, but it does appear to have accelerated somewhat in recent months.  The uptick in mortgage rates and the beginning of the seasonal Spring pickup in housing market activity may keep the market under pressure.

There are ongoing pressures to the housing market including refinancing of interest-only loans that are now more costly, the risk that long-standing tax incentives to investors are removed or limited after the next election, a supply overhang, and sustained tighter lending standards.  The sustained fall in house prices, falling for almost one-year, may itself feed negative sentiment for the housing market.

The RBA has acknowledged in their statements that “One continuing source of uncertainty is the outlook for household consumption.”  Falling house prices and the high household debt levels threaten to dampen consumer spending.

There is probably nothing new the RBA can say about the housing market, but it remains a potential larger drag on broader economic activity.


AUD still in the slot

The RBA has said in recent reports that “The Australian dollar remains within the range that it has been in over the past two years.”

In his testimony to parliament last month, RBA Governor Lowe appeared to give the green light for a weaker AUD he said, “some further modest depreciation would be helpful.”

The AUD/USD has fallen significantly in the last month and this year.  However, the fall is much less pronounced on a TWI basis.  Much of the fall reflects a stronger USD; including against Australia’s largest trading partner China.  As such, the RBA does not need to adjust its assessment of the AUD.  And, in any case, would appear to welcome the fall in the last month.