Australian interest rates July 2015

Rates were on hold in July ...

As expected the Reserve Bank Board left the cash rate unchanged at 2.00% at its July Board meeting. There were very few changes in the Governor’s statement from the one released following the June Board meeting.

... & the associated statement ...

Notwithstanding the fact that the Australian dollar had declined from around 77¢ at the June meeting to around 75¢ on the day of the July meeting, the Governor repeated his comment, “Further depreciation seems both likely and necessary, particularly given the significant declines in key commodity prices”. With the ongoing plunge in the iron ore price and persistent uncertainty around Greece, in addition to the sentiment impact of turbulence in Chinese stock markets, the AUD has now fallen further to 74½¢.

... was very close to its predecessor.

The closing paragraph in the Statement was also almost identical to its predecessor, with the key sentence remaining: “Information on economic and financial conditions to be received over the period ahead will inform the Board’s assessment of the outlook and hence whether the current stance of policy will most effectively foster sustainable growth and inflation consistent with the target.” That effectively means that the Bank is prepared to move on rates if it deems that necessary and effective, squashing any suggestion that 2.00% is some agreed floor for the cash rate. That sentiment was even more clearly enunciated in the Governor’s speech on June 10 when he said “We remain open to the possibility of further policy easing if that is, on balance, beneficial for sustainable growth”.

While the Bank would be disappointed ...

The commentary around the Australian economy included some interesting deviations from the June statement. Firstly, in June the Governor indicated that “Household spending has improved”. That sentiment would have been based on the expectation that household spending would print a 0.7% rise in the March quarter national accounts which were due to be released the following day. Along with a strong 0.9% pick up in the December quarter that would have indicated that the annualised pace of spending had picked up from 2.5% to 3%. However the accounts recorded that spending grew by only 0.5% and the December quarter was downgraded. Overall the conclusion has to be that household spending remains stuck around a 2.5% pace rather than lifting as had been anticipated by the Bank at the time of the June meeting.

... with sluggish Q1 consumption ...

On the other hand the June statement excluded any discussion on employment whereas in July the Governor stated that “the rate of unemployment, though elevated, has been little changed recently”. Even though that appears to be a bland statement of the facts the decision to point that out must indicate that the Bank is less convinced that the unemployment rate will rise consistently through the course of 2015.

... there is not yet enough evidence ...

Westpac’s current view is that rates will remain on hold through both 2015 and 2016. However the risks are clearly to the downside and will be dependent upon the Bank’s confidence in the outlook for the unemployment rate and economic growth. We continue to expect the unemployment rate to edge up further. While there appears to be some evidence that the Bank might be having some doubts around the long held view that the unemployment rate would edge up further we think that remains the core view.

... to lower their 2016 GDP forecast ...

Secondly, the RBA currently expects that GDP growth will lift from 2.5% in 2015 to 3.25% (trend) in 2016. Any substantial downward revision to that 2016 estimate should trigger a further policy response. The next test of that forecast will come in August and while there is a case for the Bank lowering that number to 3% that is not sufficient to support another rate cut. For that reason we think the first practical ’window’ for lower rates would be November when the data may be pointing to a softer growth outlook.

... which is the key swing factor ...

Markets are now more confident of a rate cut, pricing in a probability of around 40% for a cut by August and 100% for a cut by November. While we see little chance in August the most important signal to await will be the Reserve Bank’s growth forecast for 2016 and the underlying assumptions behind these forecasts. Recall that in its last two forecast revisions, in February and in May, the Bank assumed “market pricing”. Adopting that policy again would certainly encourage markets to retain the confident view that rates will be cut further in November. Such a decision in November would be associated with a downward revision to the growth forecast in 2016 to a “below trend” 2.75%, noting that without the rate cut, the figure would have been even lower.

... in the outlook for policy.

The most important determinant of that forecast will be the momentum in the economy in the second half of 2015. By the November Board meeting the September quarter national accounts will still be one day away, making it difficult to gauge momentum in 2015H2. As with this year that would tend to push any further cut into the first half of the following year. For our part there is not yet sufficient evidence to lower those growth numbers to the degree required to justify a rate cut. Consequently we retain our position that rates will remain on hold in 2015 and 2016 while recognising that the risks to rates are definitely to the downside.

Bill Evans, Chief Economist

Past performance is not a reliable indicator of future performance. The forecasts given above are predictive in character. 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 results ultimately achieved may differ substantially from these forecasts.

Reproduced from the July 2015 edition of Westpac's market outlook

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