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.
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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.
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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.
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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%.
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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.
- 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.
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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
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