Despite the surprise decision by the Bank of Canada to cut interest rates this week, the case for a corresponding Reserve Bank of Australia interest rate cut at its next policy meeting on Tuesday, February 3 is not especially strong. Our view is based on several factors – the most important of which is that the labour market could already be turning around.
- The surprise drop in the unemployment rate to 6.1% in December could be an aberration, but it is consistent with the much earlier upturn evident across a range of forward looking labour market indicators over the past year. The ANZ Job advertisements series, along with the NAB and Dunn & Bradsheet’s respective employment indices have all been moving higher for some time. Annual growth in non-farm GDP – another key leading indicator of employment – has accelerated from around 2% over 2013, to a near-trend 3% pace by mid-2014.
- The $A is much more competitive, and further weakness seems likely. On a trade-weighted basis, the $A has dropped by 7.7% since late September. That said, the $A still seems a little overvalued relative to the decline in commodity prices, the price trend still appears downward and further weakness seems likely as the US inches toward raising official interest rates. A weaker $A should boost inflation over the next few quarters, and should help to boost sentiment among trade-exposed industries.
- Weaker oil prices should help consumer sentiment and spending. Although Australia is a net-energy exporter – with firms hurt by weakness in coal and LNG prices – we are a net-importer of oil. That means the near 50c drop in petrol prices over the past six months should be saving the average household around $15 per week (assuming an average purchase of 30 litres) or 2% of after-tax income. While the bounce in consumer sentiment has so far been modest, it’s premature to believe there will be little impact – especially if oil prices fall further.
- Housing demand remains firm. While affordability constraints may be starting to cool demand in some hot pockets of the established housing sector, underlying demand for new homes remains solid. Home building approvals surged 7.5% in November, led by investor interest in multi-units. According to the Housing Industry association, new home sales rose further in November, and demand for units especially remains solid.
- The RBA’s bark may be as good as its bite. Rather than suddenly cutting rates in February (with little warning), the RBA might be able to just as easily support consumer sentiment, should it desire, without actually cutting rates at all. It could potentially achieve this outcome by changing the tone of its statements. If next week’s December quarter CPI report is benign, for example, the RBA could simply revert to its previous rhetoric, which suggested low inflation leaves it with “scope to ease policy further, should that be necessary to support demand”.
- The RBA should save its ammunition, as it may be needed later. Due to weak commodity prices and falling mining investment, the economy still faces significant challenges. Leaving interest rates steady for now would leave the RBA better flexibility to respond more forcibly to demand weakness later should that be needed.