Rates to remain on HOLD

The Reserve Bank Board meets next week on December 1. We are confident there will be no change in the overnight cash rate. Our reading on Reserve bank thinking at the moment is that the Governor is unconvinced that lower rates will boost activity.

In the Q&A following a dinner presentation on November 24, he noted that he was prepared to cut rates: “I am more than content to lower rates if that actually helps”. However, the governor also indicated that he expected that signalling a period of stability and pointing out the positive developments in the economy might have a more constructive impact on confidence and growth than lowering rates.

We know that the bank sees interest rates as 'bringing forward' activity, but doubts whether that effect would spread much beyond residential construction with non-mining investment decisions being unaffected by the level of short-term rates.

We have seen more evidence in the September quarter capital expenditure survey around the weakness in investment, including services (down 10 per cent/qtr) with total investment falling a staggering 9 per cent in the quarter.

Of some comfort is a modest lift in the outlook for services investment in 2016/17 with the 6 per cent fall we saw in the June survey being scaled back to 4 per cent. Non-mining investment decisions are being impacted by high hurdle rates, a perceived need to further strengthen balance sheets, political uncertainty (significantly reduced with the change in leadership), and soft current and expected demand.

The Reserve Bank appears to believe that lower short-term rates would do little to offset those headwinds. It appears to believe that lower rates would only bring forward housing construction activity, creating an 'activity gap' later in the decade.

While this psychology persists, there is little chance of a decision by the board to cut rates. Indeed the Governor encouraged market participants attending the dinner to effectively loosen up, enjoy the Christmas break and take another look at the economy next year.

That eliminated any possibility of a December move. Recall that as recently as a month ago, market pricing implied a 100 per cent chance of a cut by December, with 12 out of 28 economists also predicting a move.

However, when the governor appeared to hold similar views this time last year, the following months saw a rapid reassessment. The governor’s statement after the December 2014 Board meeting repeated the constant theme through 2014 that the "most prudent course is likely to be a period of stability in interest rates”. By February the following year, the board had cut rates by 0.25 per cent and re-formulated its forecasts on the basis of a follow up cut in May.

Westpac predicted that rate cut despite the 'stability' remark being repeated in the December statement. That was because the print on the September quarter national accounts was particularly weak at 0.3 per cent/qtr; the annual national accounts had indicated a weaker economy for the year to June 2014 with annual growth revised down from 3.1 per cent to 2.8 per cent (mainly due to a weaker trajectory for consumption); investment plans in the September quarter capital expenditure survey continued to point to a sharp (7.5 per cent) fall; and iron ore prices were falling sharply (down 26 per cent over three months).

This time around we expect the September quarter national accounts to print 0.7 per cent/qtr (due to a 1.3 percentage point contribution from net exports although we expect a comparable 0.5 percentage point drag from contracting domestic demand); the annual national accounts only showed a 0.2 per cent downgrade to annual growth being attributed to government expenditure and mining investment (rather than the structurally more important consumption); capital expenditure plans for 2016/17 have improved a little (from -24.3 per cent in June to -20.9 per cent in September) including that modest improvement in the outlook for services investment; and the fall in iron ore prices has been 'only' 20 per cent.

It is also reasonable to assume that as rates move lower, the 'hurdle' to cut rates gets more formidable. The Australian dollar was also a bigger headwind last year, holding around US0.82 in December 2014 compared to US0.72 currently, with the realistic prospect of renewed weakness once the Fed begins its tightening cycle on December 18. Of course, there has also been a marked change in attitude towards the labour market.

Last year, the RBA believed the unemployment rate would continue edging up until mid-2015 (at least) whereas the current forecast is 'stability' with some prospect of falls in the unemployment rate. In conclusion we remain comfortable with our current view that the RBA will keep rates on hold through 2016. We are not expecting a repeat of the sharp 'about face' we saw this time last year. But, undoubtedly downside risks are to the fore.

Contracting domestic demand in the September quarter; falling iron ore prices; negative investment plans; and downgrades to GDP growth are all comparable with the main motivations behind the sharp reversal in policy in February this year. Markets are currently pricing only a 32 per cent chance of a move in February (down from 120 per cent a month ago). We can be certain of one thing: expect more volatility as the rate debate extends into 2016.

Bill Evans is chief economist at Westpac. 

Next rate move DOWN

We have revised our interest rate outlook. We still expect rates to be on the rise in 2016 as the world economy gathers considerable momentum but we now expect the RBA to cut rates further in the early months of 2015 in an effort to bolster domestic demand and lower the AUD before evidence around the world economy becomes clearer around the middle of the year. 

We expect a 25bp rate cut at the February Board meeting and another one to follow in March. 

Our initial response to the September quarter national accounts was that the Reserve Bank would accept that the dismal growth profile was due to a lumpy fall in government spending; a temporary pause in the dwelling investment upswing; a sharper than expected drop in mining investment; and the fall in the terms of trade, which was already known to the policy makers. 

However on reflection we think that the weakness in the accounts – including falling inflation; contracting national incomes; and a loss in growth momentum – coupled with further sharp falls in commodity prices, continued weakness in consumer sentiment – which has failed to recover from its post-Budget fall – and the prospect of a further significant negative shock to confidence will be enough to prompt the RBA to use some of their remaining policy ‘scope’ and lower rates further.

At a dinner for the Australian Business Economists on November 25 Deputy Governor Lowe emphasised that he expected that monetary policy still worked, even with rates at record low levels, and that if the outlook were to deteriorate sufficiently, policy could be eased further. The risks embodied in the national accounts – where all states but NSW contracted, national income contracted for a second consecutive quarter (widely reported as an ‘income recession’) and inflationary pressures eased markedly – would be sufficient for the Bank to revise down its already downbeat outlook for 2015. 

We have lowered our GDP forecast for 2015 from 3.2% to 2.7% (below trend) and we expect that the RBA will make a similar adjustment. 

Other risks around the impact of the national accounts on both business and consumer confidence are real. The Bank will receive more evidence on these issues from two more reports on consumer and business confidence and two employment reports before the February meeting. It is our expectation that the risks to these numbers are to the downside. Meanwhile unemployment looks set to rise further near term.

Until recently it appeared that the pursuit of a lower AUD and providing improved cash flow for companies and households with a mortgage which would result from lower rates, was taking a ‘back seat’ to expectations that low rates would eventually see the non-mining upturn strengthen and concerns around overstimulating the housing market. However, the RBA has made a clear shift in rhetoric in recent months, returning to the more strident language on the currency used late last year and softening concerns around housing. The pronounced and sustained weakness in the terms of trade over the second half of this year obviously lowers the fair value of the Australian dollar, and the RBA’s recent commentaries clearly imply that in their minds the currency is far from reflecting this in full, despite recent losses. In addition, ongoing QE in Japan and Europe is indicative of both global disinflation pressures and a valuation ‘premium’ for exchange rates with conventional policies.

On housing, the RBA has noted a clear moderation in price appreciation in recent months. The Bank also has some scope to use macro prudential tools to contain any further sharp upswing in investor housing activity, if it were to occur. 

Of course the next Board meeting is not until February 3 and much could change over that period. In particular, commodity prices – which have shown sharp swings in the past – could post a strong recovery from recent sharp falls. However, while we expect commodity prices to be lifting over the course of 2015, the picture on prices is likely to still be unclear in the March quarter. In fact we expect commodity prices to fall further in the March quarter prior to lifting through the second half of 2015. The Lunar New Year which begins on February 19th in 2015, adds another layer of complexity with the relative strength of the seasonal bounce back in Chinese economic activity not likely to be known to the RBA by the February meeting. That will leave them to peruse the iron ore price, Q4 Chinese GDP and the November/December partial data to aid their decision-making. We do not expect a short term positive impulse that would alter their present mindset, even though we do expect that Chinese growth will firm as the 2015 year unfolds. 

It is also important to note the following points : 

  1. The minutes to the December RBA decision – to be released on December 16 – could provide some guidance to the Bank’s thinking. This will give a more detailed account of the Board’s assessment of risks and ‘colour’ around their thinking. 

  2. The February Board meeting is likely to be the preferred timing for the Bank. It comes after the release of what we expect to be a soft December quarter inflation report and it allows the Bank to use the 70 page quarterly Statement on Monetary Policy, released 3 days later, to explain its decision. We do not think that the Bank would make such a reversal in policy for just one move. We expect the cut would be followed by a second cut in the following month (March) prior to another period of stability.

  1. We do not think that the Bank would make such a reversal in policy for just one move. We expect the cut would be followed by a second cut in the following month (March) prior to another period of stability. 

  2. Fiscal policy will remain a headwind for the economy. Although the Treasurer has committed to not introducing any harsh new cuts in the Mid–Year Economic and Fiscal Outlook, which is likely to be released in the week beginning December 14, the evidence and the rhetoric around a sharply deteriorating fiscal position will continue to unnerve consumers and businesses. 

  3. The Reserve Bank will have little or no new information on housing between now and its February meeting with the market essentially closed through Dec-Jan meaning mid-Feb will be earliest next reading on conditions. 

  4. It is our view that the Bank will be ‘surprised’ by the pace of recovery in the world economy in the second half of 2015. That will preclude any further moves. Australia’s terms of trade will improve for a period and the key issues which the Bank has been concerned about will begin to dissipate as the terms of trade lift. By mid-2016 rates will be on the rise , taking the lead from the US Federal Reserve which will begin its tightening cycle by September 2015. 

Implications for the Markets

Fixed Rates 

Markets are already pricing in a full cut of 25bps by mid-2015. Certainly any move to bring the cut forward by the RBA will lead to markets pricing in another cut. 

However swap rates are unlikely to fall too much further (the 3 year swap rate is currently around 2.6%) since the markets will be focussing on the expected first hike by the US Fed, which we anticipate is timed for September. Anticipation of that event is almost certain to trigger a rise in fixed rates in the US. That is likely to contain any further falls in fixed rates when the RBA moves. 

We are also at odds with the market in anticipating rate hikes from the June quarter in 2016 as the Australian economy derives a considerable boost from a strengthening world economy. 

The Australian Dollar 

We had been expecting to see a lift in commodity prices by year’s end but are now delaying the timing of that recovery until mid- 2015. This means that the low point in the AUD is likely to be around the June quarter, in the aftermath of the rate cuts and amid both a strengthening USD as markets focus on the first Fed tightening; and ongoing weakness in the Euro and the Yen as the ECB and BoJ embrace aggressive QE. 

As indicated above, the RBA views the currency as overvalued and would like to see it fall further. At a minimum, it would like to hold on to the losses already recorded. Westpac puts current AUD/USD fair value in the 79-81¢ range – an estimate that incorporates both the cuts introduced into our forecasts today and a lower trajectory for commodity prices out to mid-2015. 

In that scenario we see the low point of the AUD as around USD 0.80 by June 2015. Our previous forecasts were predicated on stable interest rates, higher commodity prices and a premium to fair value. We have altered each assumption in an ‘AUD negative’ direction, with the fair value premium removed from our expectations for the first time in the QE era. 

A strengthening world economy; rising commodity prices; RBA on hold with the next move up; and Australian interest rates still comfortably above US rates are likely to see AUD strengthen through the second half of 2015 and into 2016. 

As we have seen in previous episodes of Fed hikes the highly preemptive foreign exchange markets are likely to have moved largely before the first ‘well-signalled’ move. 

In those circumstances we expect the AUD will finish 2015 at around USD 0.85 and continue to benefit from strong world growth; rising commodity prices; and, rising AUD rates from the June quarter. 

Bill Evans

Chief Economist - Westpac


Murray Financial System Inquiry

David Murray (former CEO Commonwealth Bank) is due to provide a set of recommendations to the Government with respect to Australia's financial system.


Here Roger Montgomery talks to ABC journalist Ticky Fullerton about what is likely to come from the Murray report.



Aust Interest Rates - July RBA meeting

The minutes of the monetary policy meeting of the RBA Board on July 1 showed surprisingly little change from the June meeting minutes. There were three key areas of interest.

1) The Board did repeat the language used in June "Members agreed that it was difficult to judge the extent to which this [low interest rates] would offset the anticipated substantial decline in mining investment and the effect of planned fiscal consolidation".

2) The exchange rate continued to be described as "high by historical standards" and offering less assistance to growth than otherwise might have been the case had it not appreciated by 8% in 2014 when commodity prices had fallen sharply.

And 3) policy was still described as being on hold although there was a change in the language. In June "The Board judged that the current accommodative stance of policy was likely to be appropriate for some time yet"; in July "The most prudent course was likely to be a period of stability of interest rates". Arguably the June quote implies a longer period of stability than July.

Supporting point 3) was the exclusion of a comment: "Those uncertainties were likely to take some time to resolve". That flavour of a long period of inaction has therefore been somewhat watered down by the exclusion of that remark in the July minutes.

At the time of the July Board meeting the market was pricing in 9bps of rate cuts by February 2015 easing to no cuts by July 2015. The minutes chose to overlook that 40% probability of a rate cut by stating that "In Australia market expectations of future cash rates were little changed over the past month and the cash rate was currently expected to remain unchanged for at least the next twelve months".

If the Bank had wanted to highlight the risk of lower rates it could have chosen to point out the almost 50% probability from market pricing of a rate cut by February next year. Over the course of the last two weeks, that market priced probability has risen to around 60%.

The commentary on the domestic economy continued to emphasise the positive developments in the residential construction sector while remaining cautious around the labour market. Dwelling investment was described as: "fastest pace seen in around a decade" while the labour market had "improved a little" and lead indicators were pointing to "only moderate growth". The Bank's liaison indicated that "wage growth was likely to remain subdued for some time".

Liaison also noted that retail conditions were little changed over the May-June period. Since the meeting it was reported that retail sales in May actually contracted by 0.5% therefore probably providing a negative surprise to the Board.

The slowdown in the established housing market has been recognised – "house price inflation slowed" and "loan approvals were little changed over the last six months".

There was a little more optimism around non-mining business investment being described as "picking up gradually".


Despite market pricing now pointing to a rate cut over the next six months there's no evidence in the minutes to indicate that the Board is seriously considering this option. The best way to assess the current policy stance is that the Bank is quite comfortable to await further developments before committing to any policy option. It does not appear to be particularly worried about the emerging weakness in the consumer sector and provides strong emphasis around the sharp lift in residential investment. That view around the consumer may well have been jolted by the release of the May retail sales numbers which showed a 0.5% contraction.

As discussed above, the most curious aspect of these minutes appears to be that the Bank may be preparing to shorten the 'on hold' policy stance. This may be over-reading the subtle changes in the commentary but the decision to exclude "Those uncertainties were likely to take some time to resolve" and "some time yet" in the final sentence may be interpreted in that way.

For our part we remain comfortable with our call that rates will be on hold until the September quarter next year.


Bill Evans

Westpac Chief Economist

Westpac no longer expect rate cuts

Summary: Westpac has revised its profile for the Reserve Bank cash rate in 2014.  Previously we expected that rates would be reduced by .25% in both August and November 2014.  The forecast is now for flat rates throughout 2014.  As before we do not expect a rate hike until the third quarter of 2015, with a .25% increase in both the Septemer and December quarters.

Our dominant theme in this cycle has been that a weak labour market would undermine consumer spending which in turn constrains investment, employment and incomes. Businesses react negatively to soft demand; an uncertain global environment and a “still high” AUD. Those forces are expected to be complemented by a number of known headwinds - mining slowdown; fiscal restraint; falling terms of trade and a resilient AUD as global growth, including in the US, disappoints.

We still see those forces operating to moderate growth and inflation pressures but now assess that better news on employment; consumption; and business confidence will dampen those contractionary forces to exclude a sufficiently strong case to cut rates. This is in the context of a high hurdle from the perspective of the Reserve Bank to further cutting rates. Equally, however, there will be no case for higher rates for 18 months or more. Details behind this view change are set out below :

1. The upward revisions to the current state of the labour market as indicated by the February jobs report where jobs growth in February was reported as 47,300 (80,500 full time) and January was revised up from –3,700 to 18,000 painted a much more normal picture of the Australian jobs market. That meant that the dismal start to 2014 of –10,400 in the previous 3 months was revised to a modest but respectable 41,000 over the three months to February. We accept that there were probably sampling issues with this report but that revised picture of the labour market now seems more consistent with recent lead indicators of employment intentions in the business surveys (which have recently lifted). It is true that the unemployment rate was unchanged at 6% and we still expect that the unemployment rate will increase from this point to reach around 6.5% by year’s end. However, whereas before we saw the risks to that forecast to the upside they are now tilted to the downside.

  1. We have been impressed by the momentum in household spending in the final quarter of 2013 (up 0.8% real); the upward revision in spending growth in Q3 from 0.4% to 0.7%; and the surprising 1.2% print for retail sales growth in January. That momentum is partly associated with the lift in Consumer Sentiment to a peak of 110 in November last year. The recent drop in the Index to 100 is indicating a slowing in that momentum in the second quarter but not to a pace that would, of its own, trigger a rate cut.

  2. Public comments from Reserve Bank officials and recent written commentary point to the Bank having a “high hurdle” to cutting rates. The improved picture for the labour market and consumers has now, probably, made that hurdle just too high.

  3. Offshore developments have added to the rate cut case. The terms of trade will have fallen in Q1 while the AUD has remained stubbornly high. However, due to supply constraints in the key commodity markets, we do not envisage a fall in terms of trade in 2014 much beyond 6%.

  4. The Westpac Melbourne Institute Index of Unemployment Expectations has reached a 5year high. Households are nervous about their job security and that is likely to weigh on household spending going forward providing further support for a “soft spot” in consumer spending in the June and September quarters. That is likely to keep rates on hold, although more positive trends in the labour market are likely to see that “soft spot” insufficiently threatening to warrant a rate cut. 

  5. Dwelling approvals have lifted markedly. They are now up by 35% over the year to January 2014, indicating a solid lift to residential building in 2014. We have always anticipated that lift to construction activity but had expected that the slow down in the momentum in overall consumer spending would largely offset that boost. With consumer spending momentum holding up better than expected that offset is now seen to be less significant.
  6. In preliminary calculations we have raised our forecast for headline inflation in the March quarter 2014 from 0.6% to 0.7%. At this stage we retain our call for the core inflation print of 0.6% but recognise that the risks on the core are now to the upside. Note that the Reserve Bank's implied forecast for core inflation in the March quarter appears to be 0.8%, with the assumption that the pass through from the fall in the $AUD in 2013 will take longer to work through than just in the December quarter 2013. If the Reserve Bank's forecast is correct then rate cuts would be firmly off the table.

8. Growth in housing finance has been very strong, up 26.9% for the year to December and 22.3% for the year to January. Within that, loans to investors slowed from 40% (in December) to 28.6% in January. Owner occupiers slowed from 19.4% (December) to 18.6% (January). The "time to buy a dwelling" index from the Westpac Melbourne Institute Consumer Sentiment Survey is down by 16.8% from its September peak. There are tentative signs that housing lending might be slowing. As discussed, that slowdown, which has always been core to our forecasts, appears to be  evolving. However, such a slowdown was a necessary but not sufficient condition for lower rates.

9. We retain our forecast for an improvement in the condition of non mining equipment investment from a contraction of 11.5% in 2013 to a modest lift in 2014 of 3.4%.

The Australian Dollar. Our previous profile for the AUD included resilience around 90¢ until the market started to forecast the anticipated rate cuts. We still see most of the contractionary forces operating in the economy but not sufficiently strong to trigger a rate cut from the RBA. We also expect a fall in the terms of trade and a higher USD. Accordingly we are retaining our directional forecast for a lower AUD through 2014 with a target end point of 87¢ by March 2015 rather than the lower 85¢ when we expected rate cuts.


Bill Evans - Westpac Chief Economist


The information may contain material provided directly by third parties, and while such material is published with permission, Westpac accepts no responsibility for the accuracy or completeness of any such material. Except where contrary to law, Westpac intends by this notice to exclude liability for the information. The information is subject to change without notice and Westpac is under no obligation to update the information or correct any inaccuracy which may become apparent at a later date. Past performance is not a reliable indicator of future performance. The forecasts given in this document 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 ultimate outcomes may differ substantially from these forecasts. 


RBA Holds steady on rates, but retains easing bias, next move down

As expected the Reserve Bank Board decided to leave the cash rate unchanged at 3.00% at its April meeting. 

Given that there has been some discussion in the media around rates rising this year we were very interested to see whether the Governor indicated whether he still had an easing bias. That was confirmed by repeating the term: "The inflation outlook, as assessed at present would afford scope to ease policy further, should that be necessary to support demand". We read this as indicating that the Bank's current stance is that they see it more likely that the next move in rates will be down rather than up. Of course a further assessment of the inflation outlook will be available on April 24 and that will be an important input into whether the Bank still sees scope to ease. Our early forecast is consistent with inflation remaining contained and the Bank's medium term target for both headline and underlying measures to be retained at 2.5%. 

The second area of considerable interest from our perspective in the statement was the official assessment of the surprise jobs growth in February of 71,500. Comments from Bank officials following that print around sampling variability and continuing prospects for rising unemployment indicated to us that the number would be severely qualified. In the Governor's statement in March he referred to the labour market as: "with the labour market softening somewhat and unemployment edging higher conditions are working to contain pressure on labour costs". In today's statement he is much more concise: "labour costs remain contained". This suggests that the Governor is not prepared to accept that the job report signals an improving market but he is also not prepared to publicly dismiss the number. He has left the issue open until we see further evidence around the labour market.

There were some issues around the domestic economy where the wording was a little more positive than in March: 

1. "Dwelling investment appears to be slowly increasing" (March) vs "dwelling investment is slowly increasing" (April); 

2. "Demand for credit is low" (March) vs "Demand for credit has also remained low thus far" (April);

3. "Investment generally outside the resources sector is relatively subdued though recent data suggest some prospect of modest increase during the next financial year" (March) vs "the near term outlook for investment outside the resources sector is relatively subdued a modest increase is likely to begin over the next year" (April);

4. "Though the full impact of this [easing in monetary policy] will take some more time to become apparent there are signs that the easier conditions are having some of the expected effects" (March). Arguably  the following statement is stronger: "there are a number of indications that the substantial easing in monetary policy is having an expansionary effect on the economy" (April).

On the other hand there appears to be a little more urgency around the slowdown in mining: "the peak in resource investment is approaching" (March) vs "the peak in resource investment is drawing close" (April). Secondly: "the exchange rate remains higher than might have been expected" (March) vs "the exchange rate, which has risen recently, remains higher than might have been expected" (April).

On the international front there appears to be little recognition of the threats posed by Cyprus to Europe. Global growth is still described as "a little below average for a time" while "the downside risks appear to be reduced". That is a less confident commentary than "downside risks appear to have lessened over recent months" (March). Unlike March where financial strains in Europe are described as "considerably reduced" there is no commentary on developments on financial strains but Europe is now described as: "remains in recession". Whereas in March financial markets were described as "remain vulnerable to occasional setbacks" they now "remain vulnerable to setbacks" implying a higher probability of these developments.

For the domestic economy there are a number of more positive nuances in this statement than we saw in March around dwelling investment; non mining investment; and the overall impact of the easing in policy. The Governor has sidestepped the issue of the February employment report but is no longer prepared to refer to a softening labour market or rising unemployment. On the other hand there is a little more urgency around the peak in the mining boom while the rising Australian dollar continues to represent concerns. 

By retaining the easing bias the Governor is signalling to us that in the Board's view, despite some more positive nuances, rates are more likely to be cut than increased at the next move. He has not moved to a neutral bias or used language to suggest that he expects rates to be on hold for an extended period. 

Accordingly, it is our view that the arguments around both domestic and international economies still support lower rates. Accordingly we retain our position that rates are likely to be cut by 25bps in June, or shortly thereafter.

Bill Evans
Chief Economist
Westpac Institutional Bank


This material has been provided for general information purposes and must not be construed as investment advice. This material has been prepared without taking into account the investment objectives, financial situation or particular needs of any particular person. Investors should consider obtaining professional investment advice tailored to their specific circumstances prior to making any investment decisions and should read the relevant Product Disclosure Statement.